What sets the uber-rich apart from everyone else? The nation’s top wealth holders — who the Internal Revenue Service (IRS) defines as those with gross assets of $11.4 million or more — have multiple sources of income, including stocks, bonds, real estate, and private equity funds. This diverse group of investments generates consistent passive income, earning money without having to put in any labor.
While you may not have the resources of an Elon Musk or Jeff Bezos, learning how to make passive income can allow you to build long-term wealth and even retire early.
“Earning passive income can be an excellent way of moving yourself from having to ‘work’ 40 plus hours a week, and beginning to replace that income with something that does not require as much involvement by you,” said Lawrence Sprung, a certified financial planner (CFP) with Mitlin Financial.
Learn more: How to start investing: A 6-step guide
Usually, your income is tied to work. You earn a salary or an hourly wage in exchange for your labor and time at your job.
By contrast, passive income is a source of income that requires little to no active effort, and investing can be a powerful tool for generating passive income.
“Investing can be used to create passive income,” said Sprung. “The proper allocation, savings amount, and discipline can provide you with an income stream outside of your 9-to-5. This income stream will not require any real manual labor or effort on your part once you have it set up.”
As an investor, you can earn passive income in the form of interest, dividends, and market growth.
Whether you’re a seasoned investor or just starting out, here are five top ways to make passive income.
This approach is one of the easiest and lowest-risk options; you can open a high-yield savings account or money market account and earn interest on your deposits.
Learn more: 10 best high-yield savings accounts
Although the national annual percentage yield (APY) on money market and savings accounts is under 1%, it’s possible to find banks that offer significantly higher rates. Some even have savings accounts or money market accounts with APYs of 4% or better.
For example, if you deposit $1,000 into a savings account that earns 4% APY, and assuming you leave that money untouched and that interest compounds monthly, you’d have $1,490.83 after 10 years. With no effort on your part, your money generated $490.83 in passive income.
When it comes to earning substantial passive income, investing in the stock market is a crucial next step.
Learn more: Create a stock investing strategy in 3 steps
“Stock price appreciation and stock dividends are about as passive an investment as you can get once you’ve bought the shares,” said Ronnie Colvin, a certified financial planner and founder of Fractional Planning. “You get paid simply for owning it.”
As Colvin noted, there are two main ways to earn passive income through the stock market:
-
Dividend-paying stocks. Some stocks pay their shareholders dividends, meaning they distribute a portion of their earnings to their investors. Dividends can be in the form of cash or shares. If you have a portfolio of dividend-paying stocks, you could earn income at regular intervals, such as monthly or quarterly.
-
Market growth. Stock price appreciation can be the biggest driver of long-term growth to your portfolio balance, making investing an effective tool for retirement planning. According to the U.S. Securities and Exchange Commission, over long periods, the stock market has historically provided an average annual return of 10%.
For example, you’re 25 and deposit $1,000 into an investment account, investing in a variety of stocks. Even though you never contribute another dollar, your account earns an average annual return of 10%, so by the time you’re 65, your account will have grown to $53,669. Thanks to market growth, you earned over $52,000 without having to do anything at all.
Colvin says the main ways to generate passive income via real estate are through home equity gains or investing in real estate investment trusts (REITs).
Learn more: How to invest in real estate
-
Home equity gains. When you purchase property, the combination of paying down your loan balance and increasing property values over the years builds home equity. Core Logic reported that nationally, U.S. homeowners saw their home equity — how much their property is worth minus how much they owe on their mortgages — increased 2.5% nationally from last year. You can reap the benefits of the increased equity when you sell the property.
Learn more: 7 ways to build equity in your home
-
Real estate investment trusts (REITs). A REIT is a company that owns and operates investment properties. It sells shares to investors to generate capital it can use to buy and maintain properties. As an investor, you can earn income from real estate without having to manage the property yourself.
Expert advice: Owning an investment property and renting out units is often touted as a powerful source of passive income. However, becoming a landlord may require more work than you’d expect.
“Never, ever, fall for the trap of assuming that real estate investing leads to passive income,” cautioned Colvin. “Anyone who tells you that buying and renting out property — residential or commercial — is passive income has never actually bought property and rented it out. Nothing about being a real estate investor is remotely ‘passive’ with the single exception of buying shares in a REIT, which is just a market investment like shares in a company.”
Learn more about the real estate sector of the stock market at Yahoo Finance
If you’re looking for alternative passive income ideas, another option is to lend out money on a peer-to-peer lending platform like Prosper, for example. With these platforms, you pool money with other investors’ funds to provide loans for borrowers looking to consolidate debt, finance a medical procedure, start a business, and more.
You could potentially get a higher return than you could get with a savings account or with stock investments, but there is a higher level of risk; if the borrower defaults on the loan, you could lose your money.
If you’re wary of putting all of your money into stocks, purchasing bonds can be a way to diversify your portfolio and generate passive income. With bonds, you’re basically giving the issuer — usually the government or municipality — a loan. In exchange, the issuer agrees to pay you interest and repays the principal once the bond reaches its maturity date.
Bonds tend to have higher APYs than standard savings or money market accounts. Certain types of bonds, such as Treasury bonds, pay a fixed rate of interest at regular intervals.
Plus, there can be tax benefits to bonds.
“Certain types of investment products can get you some tax-free income, like government bonds,” said Colvin. “The tax benefits you get from federal or municipal bonds are a nice perk, but they won’t make you rich or even pay your mortgage unless you own a lot of them.”
As a result, bonds are often a complementary part of your total investment portfolio and financial strategy rather than the primary driver.
Learn more: What are bonds, and how do you invest in them?
How much you can earn in passive income depends on what investments you choose, your age, and your time horizon. As an example, if you started investing in the stock market at 25, invested $500 every month, and assumed an annual rate of return of 10%, you could have over $3.1 million by the time you retire at 65. You’d contribute just $240,000, and your money would grow by over $2.9 million thanks to stock appreciation.
You don’t need thousands of dollars to start building passive income. You can open a brokerage account or individual retirement account (IRA) with just a few dollars and begin investing in stocks, bonds, and other securities. Over time, your investment can grow, allowing you to earn dividends and passive income.
Learn more: Robo-advisors: How to start investing right away
How your passive income is taxed depends on how it’s earned, the accounts you use to generate it, and when you access the cash.
For instance, interest you earn in a savings account or money market account is taxed for the tax year it’s earned. For stock investments, you’ll have to pay taxes on capital gains unless the money is in a tax-advantaged account like a 401(k) or IRA.
Learn more: 401(k) vs. IRA: The differences and how to choose which is right for you
Keep in mind that taxes can eat into your passive income.
“Savings account and money market accounts generate regular streams of income in a passive manner, but you also need to be mindful of what your actual after-tax, inflation-adjusted return is,” cautions Sprung. “Just because one of these ‘safe’ investments are producing an income stream of 4.5%, that doesn’t mean you’re keeping that full amount. Assets like these, which are held in non-retirement accounts, will be taxed, which reduces your overall return, and you have to factor in inflation, which will also reduce things further.”
