What is Passive Income – Definition, Benefits and Examples

Passive income is essential in your FIRE strategy. Here the definition, benefits and some examples of passive income and how to earn it
Learn All About Passive Income

Since childhood, you must have been taught about working hard and learning every possible skill for your financial success and stable future. All these skillsets are supposed to be put into our regular job which takes almost 8-9 hours/day during the whole contract period. Through our active job is the pillar of our incomes, there is something else that every all people do in order to secure and boost their financial status. That is to earn extra money by creating a stable source of passive income.

The concept or idea of Passive income has a number of myths such as, it is free, it is useless, so on and so forth. We are going to discuss every query you might have regarding passive income in this article.

What is Passive Income

“Passive income is money earned with little to zero effort”, this is what you might have heard about passive incomes and that perhaps, might have drawn your attention towards it. Well, that is only half the truth. Here is our definition of passive income.

Passive income is a regular flow of income, created by spending effort, time, and money upfront and then reducing the active participation at a later stage, at which point money is earned with little to no effort.

passive income

In passive income, you are going to generate very little cash in the beginning, with failure and frustration as add-ons. But these challenging scenario is going to be the pillar of your patience, experience as well as income level. The more you fail, the more you learn and the more you will earn.

What are the benefits of Passive Income?

perks of passive income

Passive income is not just about earning extra money, it is also about thinking long term and creating a  number of income sources that buy you financial freedom to do what you want. It has certain perks and benefits that are important for financial growth:

  1. Over a period of time, you will reach financial freedom and can quit your regular job if required
  2. You will always have cash in hand which creates extra security
  3. Do you know how the rich gets richer? By reinvesting. Your portfolio income can be reinvested to futher grow your wealth
  4. It will strengthen your retirement corpus and help you go for early retirement
  5. Additional income and financial stability gives you emotional happiness and time to do things you care about

Now, let us see what makes passive income different from other sources of income.

Active or Standard Income vs Passive Income

In traditional or active income, you perform some job and you get paid for your time, effort, and skills.

When earning money passively, you have already done some work or invested money, time or energy. You are simply earning a steady stream of revenue that is recurring in nature. This could be from any source such as a Fixed deposit that pays interest, stocks you bought those pay dividends or even a REIT or rental property that gives you a recurring rental income.

There is just one criterion for side income to be classified as Passive. That is, it should not require much work from you. You should be getting the money without exerting effort or investments at the later stage.

Example of Passive Income

If you are a partner in a business and are working there, the money you earn from it is standard income.

Instead, if you are a sleeping partner in the business, the money you get from it is passive cash, as you are not putting in any effort into that business.

And, passive income gives/saves you something more valuable than money which is Time!

Time is the most valuable and proportional asset each individual on this planet has and how one utilizes it changes the game. For e.g., if you have a passive income stream in a real estate investment trust, you get the extra time to invest somewhere else.

In the active income, you have to regularly trade your time for money while passive income is time-independent.

Types of Passive Income generating sources

sources of passive income

Generating cash without doing work is not easy during the initial stage. You need to put in hard and smart work to be able to have money coming to you every month. All sources that provide a passive return can be classified under two major headings based on your major input being time or money.

Income earned by investing

This is when you have cash in-hand and make passive income investment that is optimized to give you a monthly income. This type of investment income generate regular, recurring cashflow for you that grows over a period of time. The effort required for this is lesser compared with other passive income opportunity.

  1. Decide how much you can invest
  2. Decide your time frames on when you want to retire, how soon you need the monthly passive income etc
  3. Identify the different investment opportunity available to you in your budget and time frame
  4. Execute and make the investments
  5. Be patient and wait for the money to start trickling in

Remember, to be cautious when investing, seek help from a financial advisor or a retirement planner when taking big decisions.

Income earned by effort

You may not have much money, but have great skills. Then you can put the effort to create something that will get you money regularly.

Videos that you create can generate advertisement income on Youtube. Books you write can generate royalty, apps you build that people continue to buy are all examples of this.

  1. List down all the skills that you are a master of
  2. Figure out how you can monetize these skills
  3. If there are skills that you are not a master of yet, learn till people are willing to pay you for it

How to earn Passive money

There are a lot of creative ways you can create passive income streams and start earning money every month.

Step 1: Assess what your strengths and capabilities are.

Step 2: clearly understand how much time and money you can invest in order to pursue the passive income idea you select.

Step 3: go through our list of passive income strategies and additional income ideas to find out what is the best one for you to start earning.

If you work in a high salaried company or have a good strong business, then you can choose some of the investment sources that provide a monthly return on your investment.

On the other hand, if you are studying, working, on a low salary or don’t have a job then, choose a way where you monetize your skills and abilities to create streams of income.

Here are some passive income strategies you can adopt for your self.

Passive Income Strategies

Some of the passive income strategies you can apply to earn money passively by investing:

  • Starting a blog by writing articles, uploading video content on Youtube.
  • Internationally providing your service as a freelancer via Fiverr, Freelancers, etc.
  • Leverage your fan following and become an influencer in your field
  • Affiliate marketing is one of the best passive revenue streams done worldwide. If you are interested in affiliate marketing there are a tonne of options such as Amazon, JVZoo and more. Amazon Affiliate is one of the well-known Affiliate programs as it gives you a diverse selection of products to market and the payout is regular and lucrative.
  • Creating a coaching business or tutoring one on one or in groups and one of the best extra income sources for students.

Here are a few other additional income generating ideas that require less time and more upfront investment

  • Invest in Fixed deposits: They provide a stable and low-risk low return investment option.
  • Invest in dividend stocks: Investing in the stock market is high risk and high returns. You can earn dividend (note: in some stocks dividend payouts happen annually and some stocks don’t pay dividends or have low dividend yield) and also profit from the increase in stock price. Dividend stocks are typically stable companies that pay a dividend periodically without fail and can improve your cash flow.
  • Invest in Mutual Funds or ETFs: You can consider investing in mutual fund or ETFs that would appreciate over a long period of time. While this will not directly give you recurring income, the money invested will grow over a period of time. This can then be moved to a fixed deposit which can give you the recurring income at that time in the future.
  • Loans/P2P lending: Loans are given out to generate interest. Risk varies depending on the customers and the locations you lend to. P2P lending and Peer-to-peer loans are becoming very common these days.
  • Rental Income: Investing in real estate can become a cash cow if invested right. Invest your money in buying a residential property or commercial property. You earn rent and the value of the property will increase with time.

Also, check out our detailed list of Passive income ideas to build your income stream.

Some Passive income myths busted

passive income myths

The lazy way to earn money 

This myth about earning money passively is all about what grabs the reader’s attention. Well by far, you have come to know that it is not at all true.

One is supposed to create a concrete plan along with strong backups, do a lot of research and experiment, put in a lot of time, money, effort, and energy to create the source of extra cash flow.

There is nothing lazy about generating money on the side.

Low income generated

People think that these are very low income sources and not worth the effort. Hence they give up even before they give it a shot.

In the initial phase, there will be nil to less amount of economic return. But with time, as the exposure and value of your investment increase, cash flow and earned income will automatically increase.

Starting will definitely test your patience level! But learn to be patient.

Check out Abhi’s Financial Independence journey updates. It took over a year to start seeing decent returns. Persistence pays.

Not long-lasting

This completely depends on the effort that one puts in and the smart planning that goes into designing your income generating strategy. The amount of research done and future security will decide the life of your passive income source.

Even if there is any sign of collapsing in the future, one should be able to predict that at an earlier stage. Plan in advance and keep monitoring, doing periodic reviews of your investment portfolio and income streams.

Limitations of Passive Income

Like every other thing in the world, passive income too has a few limitations. It will be a bit stressful at times, personal time will be compromised, financial loss may occur in case of uncalculated investment, etc. 

All these obstacles will be there for a period of time and can be managed by balancing the pressure and being a little bit flexible.

Keep your eyes trained on the ultimate goal of achieving Financial Independence. If your long term plan is to quit, visualize the day you will tell your boss that you Quit!

Importance of generating Passive Income in FIRE

FIRE is all about how you reach Financial Independence to Retire Early.

Financial Independence and Retire Early is a movement that motivates people to create a financially secure position in life for themselves and then retire earlier than usual.

Once you retire, you need a steady stream of money to stay retired. The money can be in the form of rental income, dividend stocks or other side hustle sources that generate extra income.

This money should cover all your expenses for the rest of your life. Additionally, this should also handle the increase in your expenses due to inflation. This is why it is important to be Financially independent, in the sense, you are generating sufficient income passively so that you are not dependent on your job for your living expenses.

Some frequently asked questions

What are some examples of Passive income?

Some good examples of passive income are rental income, interest on deposits, dividends from stocks, earnings from royalty, pensions.

How long should passive income give returns for?

It is mostly perpetual in nature and will go on as long as the underlying source is active. Eg: In rental income, you will keep getting rent from the house as long as the house is in good condition and occupied.

What is the difference between passive and regular Income?

For active/standard/normal income you need to work and put your efforts in order to earn money. Passive on the other hand is money you earn without putting in efforts.

Is passive income taxable?

Yes, money earned as passively is taxable similar to other income. In India for example, there may be different classifications and tax structures. Income earned from Fixed Deposit upto Rs.10,000 is tax free (up to Rs.50,000 for Senior citizens). Similarly, there are other tax exemptions and tax classes on royalties, patents, dividends etc. Rental income is taxed as normal income.

Where to get passive income?

You can get passive income from any source that pays a return on your investment. Or you can create assets that can earn you money such as music, apps, videos, writing, educational course content etc.

Is Pension or Provident Fund a Passive income source?

Yes, it is. Pension and Provident funds are what you accumulate working previously. Later on, once you retire, the money is paid to you without you needing to work or put in any effort.

How is Passive Income different from Residual Income?

Passive income is recurring monthly income. Residual income is the balance of money that is left over after all other expenses are covered. Passive money you earn can grow, but residual will only diminish.

How much passive income do I need to retire?

This depends on your lifestyle and when you are planning to retire. A simple way to calculate is to use the 4% rule. Just take your current monthly expense, multiply that by 12, then multiply that by 25. This is the amount you will need to retire. It varies person to person and you will need to calculate it and plan properly.

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Abhi

Abhi is a 29 yr old Indian, on FIRE to retire by 40. He has been investing and learning Finance for the past 12 years. After completing Mechanical engineering, he started working in a multi-national Bank and grew to become an AVP. Currently with an IT MNC as a VP. He lives in Bangalore with his wife and their 1 year old daughter. In his free time, Abhi loves to game on the Xbox, watch movies, read and blog.

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