What is Passive Income? A Guide to the Reality of Passive Income

Passive income sounds like a dream come true — earning money without any active effort. The reality is that there’s no such thing as 100% passive income. This type of income stream can better be described as frontloaded work: You have to put in time, effort, and (usually) money first to collect those passive returns. Even then, most passive income requires periodic maintenance and attention.

That’s not to say that passive income isn’t worth acquiring. It can give you greater flexibility and freedom and bolster your financial stability. 

However, before you pursue passive income, it’s important to get a clear understanding of what that entails. This article clarifies what passive income is, provides examples of passive income, and gives pointers on how to realistically acquire passive income.

What is passive income?

Passive income refers to money you earn with little or no active effort. It comes from sources other than your full-time job, side hustle, or a contracted client (in the case of self-employment). In any of those working relationships, you’re expected to put in hours or churn out deliverables to get paid. In contrast, passive income doesn’t require active labor. It’s often thought of as extra cash you can make in your sleep.

That’s the typical mindset when it comes to passive income. However, the truth is that passive income is a modern money myth. Most passive income streams require careful preparation. Even once they’re up and running, they require occasional attention, so they aren’t fully passive. One example is rental income, one of the most common passive income streams, according to the Internal Revenue Service (IRS).

Once a property is rented to a tenant, you don’t have to do much beyond collecting rent. Hire a property manager or property management company, and you don’t even have to worry about landlord tasks like building maintenance. However, you first need to acquire a property, get it rental-ready, and keep it that way. That upfront prep work requires an initial investment of money and effort.

Ways to create passive income

Although totally passive income might be a myth, it can still be a practical and worthwhile way to increase your earnings. Here are a few passive income ideas you can use to start building your wealth.

Buy an asset that earns passive income

There are many assets that can generate income without regular input. Portfolio income from investing — such as in dividend stocks in the stock market or mutual funds — is one example. You can also invest in real estate investment trusts (REITs). 

You can also look into short-term forms of passive investment income. Peer-to-peer lending is one example. Online platforms connect you to people who need a loan, for example, to start their own business, allowing you to act as a lender. The returns you get with interest can make this yet another cash flow source. 

You might even invest in a business long term, essentially buying a piece of it so you can collect profits.

Create an asset that earns passive income

You don’t always have to buy an asset to generate passive income. You can also create your own income-generating asset. For example, if you have niche industry knowledge about a topic, you might share it via a podcast or YouTube channel, which you can monetize. Platforms like Udemy, Skillshare, and Coursera also make it easy to sell courses.

You can also share your insider knowledge by writing an e-book, which you can sell on Amazon. While it may take some time to write, a book can earn passive money once it’s finished. 

Social media is another example of how you can leverage a creative endeavor to make money. If you already have a significant active following, you can use it to generate money through things like affiliate marketing.

Rent an asset that earns passive income

Finally, the most common example of passive income is rental properties. If you buy a property, you can rent it out long term, collecting monthly rent payments that contribute to your overall earned income. Alternatively, you can focus on short-term rentals, using platforms like Airbnb to find tenants.

At this point, it’s worth noting that any money you earn via passive income is taxable. Rental income needs to be reported on your income tax returns or you’ll risk getting into hot water with the IRS. 

However, note that you can also write off many of the expenses related to your rental property as a result, such as advertising costs or maintenance and cleaning fees.

The reality of passive income

As you can see, a passive income strategy is never 100% passive. These income streams take time, energy, and money to set up. 

That said, once you have an additional income stream, you can enjoy greater financial freedom and flexibility. Plus, you can increase your net worth by boosting your income. 

Another benefit of such passive activity is that it’s scalable. You can start small and then go bigger — for example, by buying or renting another asset that generates passive income.

Using your income to create the life you desire

While you won’t get money for doing absolutely nothing, passive income opportunities offer distinct benefits (e.g., greater financial freedom, earnings flexibility, and scalability). 

It’s also important to realize that many forms of passive income are within your reach. If you don’t have money to invest in real estate, try another source of passive income, like creating courses or selling e-books.
Too often, people assume that personal finance basics like passive income or investing are beyond their reach. This fear of money ultimately prevents them from reaching their financial goals. By embracing smart money management and recognizing earning opportunities, though, you can overcome the hurdles that keep you from living your rich life. Start making a change with our earnings potential quiz.