What Is Passive Income?

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Imagine if you could earn money simply by sitting back and doing nothing. Believe it or not, it's something countless folks do every day. It's a concept known as passive income investing, and it's what allows people like you to accumulate wealth without having to lift a finger.

Passive income essentially works like this: You make an initial investment, which generally requires you to not only put up some money, but do some legwork or research. But from that point on, you sit back and enjoy an income stream without having to make any more of a substantial effort. Some common investments known to generate passive income are stocks, bonds, rental properties, or investments in private businesses. All of these ideas allow you to keep generating cash flow over time.

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Keep in mind that the IRS has its own (strict) definition of passive income, which only covers income from rental activity or business activity in which the investor does not materially participate. Because there are tax benefits associated with true passive income, it's important to note the distinction. But for our purposes, let's talk about the various ways you can make money without having to play an ongoing, active role in earning it.

Stocks

Stocks are one of the most celebrated forms of passive income because once you've researched various companies and decided how many shares of stock to purchase, you don't have to do anything more (though you should periodically check on your investments and sell them when necessary). Imagine you decide to invest in a publicly traded pharmaceutical company. It's not like you'll ever be asked to show up at that company's headquarters and assist its research team in isolating proteins for the latest drug under development. Rather, you'll get to go about your business and wait to collect your passive income in the form of quarterly dividends.

If the stocks you buy increase in value and you sell them at a profit down the line, you'll generate additional income that way. The only difference is that whereas receiving dividends happens automatically, deciding whether to sell a stock will require a bit of thought, research, and action on your part.

Furthermore, you will need to do some initial research before throwing money into stocks. Specifically, you'll want to find companies with a strong performance history and a solid business model that offers opportunity for growth. Similarly, you never want to set up a portfolio and then ignore it indefinitely. You should always keep tabs on your investments to make sure they're performing well. But you're still looking at a small amount of legwork relative to what your investments might produce.

Bonds

Bonds are another easy way to get some passive income flowing. When you buy bonds, what you're essentially doing is lending an issuer a sum of money in exchange for semiannual interest payments. Once your bonds mature, the issuer is required to repay your principal investment, and at that point you'll have ideally collected a fair amount of interest along the way. Although bond interest, like dividend income, is technically not guaranteed (you never know when a company might default), if you buy bonds issued by highly rated companies, the likelihood of experiencing a missed payment is pretty low -- which means you can sit back and let that interest keep rolling in. And, like stocks, there's always the option to sell your bonds at a price that's higher than what you paid for them, thus generating income that way.

Rental properties

If you're willing to dabble in real estate, it could end up paying off in a very big way. That's because buying a rental property, or several properties, could set the stage for years of steady monthly income without your having to do much other than remember to cash those checks.

Now I know what you're thinking: "Don't I have to manage that rental property?" Not at all. Just hire a property manager and have that person tackle tasks such as maintenance, repairs, lease agreements, and tenant placement.

Granted, investing in rental properties does require you to get a mortgage, which can be a process. It also requires you to put up a potentially sizable amount of capital, not to mention lots of up-front market research. But once that's done, there's no need for you to take an active role.

Limited partnerships

Investing in a limited partnership is another good way to generate passive income. In this sort of arrangement, you're essentially funding a private venture with the potential to earn money, but your liability is limited to the sum of money you choose to invest. And as long as you agree that you're not going to play an active role in that venture, any associated income will be passive in nature.

Of course, these are only some of the passive income streams you might pursue. There's a world of opportunity out there, and if you're willing to be creative, you stand to collect even more money for doing very little.

For example, if you're a web developer, you might create an app that you can then sell to users so that each time someone signs up, you're getting cash. Similarly, you might compose a musical piece that, if eventually used in commercials, brings in some decent royalties. Do all of these examples count as true passive income? Not by every definition. But let's liken them to owning a rental property. You might sink weeks into researching which right area to buy in. You might then spend several more weeks looking at properties before making your purchase. But once that major effort is complete, you get to sit back and reap the rewards for what could be five, 10, or 20 years. The same holds true here.

Remember, passive income does require at least some effort; it just doesn't require a substantial ongoing effort. The best part? When it comes to passive income, the possibilities are truly endless. And in many cases, the more effort you're willing to put in up front, the greater your payoff will be down the road.

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