Why Are Passive Income Streams Important?
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Originally published January 25, 2019. This article was edited to meet broker-dealer compliance guidelines in April of 2023.
All things considered, time is our most valuable resource. We are all given a finite amount, and, unlike most resources, it cannot be recovered. To maximize the potential of this precious resource, we must be wise about how we invest both our time and hard earned money.
Building passive income streams can be one of the best investments of both - eventually leading to financial freedom and greater control over your time.
- What Is Passive Income?
- Types of Passive Income
- Diversifying Passive Income Streams
- Compound Your Passive Income Earnings
- Passive Income Investment Ideas
- Final Thoughts
What Is Passive Income?
Passive income is income that does not depend on any mandatory actions from you on a regular basis and is generated regardless of your age, health, location, or the amount of effort invested.
One of the greatest benefits of a passive income stream is that it requires very little effort to maintain and it generates automatic income. In contrast, active income streams often involve the direct exchange of your time for money.
Most of us have to work to make a living. However, if we can only produce income while actively working, we leave ourselves exposed to the threat of being unable to earn in the event of an incapacitating injury or illness.
Fortunately, passive income does not require a daily commitment to a full-time job, and the earnings keep coming even without your presence and active involvement.
If you don't find a way to make money while you sleep, you will work until you die.
If your goal is to achieve financial freedom and have greater control over your time, the more effort you put into expanding passive income streams the better—which is not to say that creating passive income streams will be easy nor require a short amount of time to get started.!
No matter which passive income strategy you choose, you will likely have to invest significant amounts of time, earning little income in the beginning.
However, keep in mind that after initial setup each income stream will continue producing income with little or no involvement, and in some cases, the underlying asset will continue to appreciate as well.
Types of Passive Income
There are two widely recognized types of passive income: those that require initial financial input and those that don’t.
1. Passive income sources that require initial financial input:
This is the most traditional and well-known type of passive income. It implies that a certain financial investment should be made in the early stages, which can later generate a solid and permanent income stream. As we know, “It takes money to make money”.
Here are some of the best forms of passive income of this type:
Savings accounts and terms deposits
Index fund investments
Investing in dividend stocks
Employer 401K matches
Real estate investments
2. Passive income with no initial financial input:
Passive income can also be generated in case no extra funds are available. In this case, investments of time, energy, and efforts are needed to create and maintain a stable passive income source.
Here are some examples:
Renting out property you own
Selling stock photos
Content monetization with ads
Diversifying Passive Income Streams
There are many ways to build passive income streams. Whether you are using your skills to make money online, investing for rental income, or in dividend stocks, you will be hedging your portfolio against more risky investments.
However, the riskier investments typically have the potential for higher returns, so you likely wouldn’t leave them completely out of your portfolio either.
The key is finding a balance to potentially protect and maximize your portfolio value and sources of passive income are great at helping you achieve this.
Diversifying your portfolio is a staple of good investment practices.
You wouldn’t want to put all of your money in stocks because values can fall over 30% in a few months.
By contrast, you wouldn’t want to place all of your money in bonds, even though they are less volatile. Your returns will be significantly lower than they could be if combined with investments in stocks.
Experience shows that is best to have a mix of both, along with other asset classes like real estate.
By also investing in non-correlated assets like farmland, which has historically increased in value when stock market values drop, you can provide balance to your portfolio and protect your overall earnings.
Farmland and property rental investments can also provide a stable annual return in the form of rent payments while the value of the underlying asset continues to grow as well.
In the end, the more you diversify your portfolio the less you expose yourself to risk.
The right passive income streams are great tools for this because they typically offer low volatility, higher total returns than your standard "safe" investment, and generate income without active involvement.
Compound Your Passive Income Earnings
The beginning of any passive income strategy is building a savings plan and sticking to it.
Once you have a realistic idea of how much you need to make to cover your expenses, you can begin to look at additional income as fuel for the machine. This also gives you an idea of how much passive income will be needed to achieve your financial goals.
As you continue to receive income from your day to day job and passive income streams, you can reinvest what you don’t need for your expenses to continue compounding its value.
This takes discipline and dedication towards your goal, but over time is one of the greatest values of this strategy.
The goal is to reach financial freedom, or the point at which you make enough passive income to cover all of your expenses. Not to say that passive income vehicles are the only way to get here.
In fact, your investments should be diversified to protect you during different market cycles as mentioned above. However, having steady income outside of your primary job that you can use to make money while you sleep is a distinct advantage.
Passive Income Investment Ideas
On the road to financial independence, there is no need to reinvent the wheel, fortunately.
However, it is important to know your options and choose the most profitable passive income source based on the amount of time, effort, and money you are willing to invest.
Here are some of the examples of passive income you can try:
Investing in farmland is, in a way, similar to other forms of real estate investments, although we have seen less volatility of returns over time with similar or higher returns over time with farmland investments.
It can be a good way to hedge against inflation, the land typically doesn't depreciate in value, you are regularly getting rental income or payments from the sale of crops.
Farmland is a relatively new asset class in investor’s portfolio since only in recent years has farmland investing become accessible as a passive investment for an average investor - even beginners without large amounts of upfront capital, years of farming knowledge, and excessive amounts of time can now become landowners using online platforms like AcreTrader.
P2P lending is a practice of lending money to private individuals or companies that seek alternatives to traditional bank financing (often due to high interest rates or low chances of being granted a loan).
When you find a loan that suits your risk tolerance, you can fund the project by yourself or with others and earn income from the interest you charge the borrower over a set time perioduntil it is paid back in full.
P2P lending functions according to the principles similar to crowdfunding and happens on specialized online platforms responsible for connecting lenders and borrowers, such as Peerform, LendingClub, or Upstart.
Rental Property Investment
Making money through real estate is one of the oldest ways to earn passive income, and can provide a good stream of income if the property has the qualities of a high-demand rental.
If you purchase a rental property, you can generally shoot for a longer-term tenant lease for more stable returns, or, if you have some time on your hands and may still want to use the property, offer short-term rentals and charge higher rates for vacationers.
Nowadays there are numerous ways to invest in real estate - from directly buying and managing the property (more active involvement) to investing in smaller installments through real estate crowdfunding platforms (little or no involvement).
Becoming a partial owner of the company through buying stock in companies that have a history of increasing their dividend payouts over time is another classic example of creating passive income. Often, the key is to continue re-investing your dividends to benefit from compounding your returns over long periods of time.
One can make more than a decent living off dividend income alone over time; however, this strategy can be risky and requires skills and knowledge to identify and pick solid stocks that will earn you a sufficient income.
Passive income streams are crucial to your portfolio because they can generate predictable income with little maintenance, diversify your portfolio, and increase your overall cash flow.
Remember, those who are the most successful are those who have the most control over their time. The more work you put into building passive income streams, the more control you will have over your precious time in the long run.
Learn more about the impressive diversification properties of passive farmland investments.
The above content is not intended to be a comparison between products, but is intended for general, educational and informational purposes only. Any performance noted is historical and there is no guarantee any trends will continue. All investing involves risks, including the complete loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. It is important for each investor to review their investment objectives, risk tolerance, tax liability and liquidity needs before investing. Investment vehicles have differences in fee structure, risk factors and objectives. Investments are considered speculative, involve a high degree of risk and therefore are not suitable for all investors.
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