As you trudge to work, perhaps suffering through traffic on a long commute, you may fantasize about earning money a different way. In the best scenario possible, you might envision earning money without working much or at all.
Believe it or not, that doesn't have to be a total pipe dream. There are lots of ways to set up passive income for yourself. Here are 10 of them:
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- Pay off debt
- Stock appreciation
- Stock dividends
- Rental property income
- Credit card rewards and cash back
- Residual and royalty income
- Affiliate marketing
- Refinance your mortgage -- or get a reverse mortgage
Let's take a closer look at each way to earn passive income. See which ones make the most sense for you.
No. 1: Interest
Interest is a classic form of passive income. You plunk some money in a bank account, certificate of deposit (CD), or a bond and you're paid interest for doing so. Depending on the economic environment, this can be a powerful or ineffective way to generate income -- or something in between.
Right now, for example, interest rates are quite low, though they've been inching up, but in the 1980s, they spent several years in the teens -- and high teens. If you have $100,000 earning 12%, that's $12,000 per year, or a hefty $1,000 per month. If you're only earning 1%, though, you're looking at $1,000 for the year and just $83 per month.
No. 2: Pay off debt
This way to generate income may be surprising, but it makes sense. Imagine, for example, that you owe $15,000 on your credit cards and you're being charged a not-unusual 20% interest on that amount. That's $3,000 in interest payments annually.
If you pay off that $15,000, though, you'll keep that $3,000 in your pocket. Paying off debt is very much like earning a guaranteed return on the debt that you retire. In this case, it would be like earning 20% -- an annual return that's hard to find anywhere else, even in the stock market.
No. 3: Stock appreciation
Investing in stocks is another great way to generate income or build your net worth. You buy stocks that you believe are undervalued and that you expect to grow in value -- or you simply invest in a low-fee broad-market index fund. That investment should grow over time (remember that stock investing is only for long-term money), making your portfolio more valuable. If you need to turn that into income, you'd simply sell some shares.
Here's what you'd end up with over various periods if your investments average 8% average annual growth:
No. 4: Stock dividends
Stock-price appreciation can be a glorious thing, but many stocks offer even more to shareholders -- by paying dividends. Aim to devote at least some of your portfolio to healthy and growing dividend-paying companies -- ideally, ones with dividends that have increased regularly and significantly and have room for further growth.
A dividend payout ratio of about 70% or less suggests plenty of room for further growth. (The payout ratio is the amount of the annual dividend divided by the trailing-12-months' earnings per share, reflecting the portion of earnings being paid out in dividends.) A payout ratio close to or above 100% reflects a company paying out more than it earns, which isn't sustainable. Here are some examples of major companies with significant dividend yields:
Another kind of dividend to collect is from real estate investment trusts, or REITs. A REIT is a company that owns apartments, office buildings, shopping centers, medical buildings, storage units, and/or other real estate properties and is required by law to pay out at least 90% of its earnings as dividends. REITs aim to keep their occupancy rates high, collect rents from tenants, and then reward shareholders with much of that income.
No. 5: Rental property income
This is an example of passive income that isn't quite as passive as it may seem. Yes, if you own one or more homes or apartments you can collect regular rent checks from your tenants. But in exchange for that, you need to keep the properties in good working order, along with insuring and paying taxes on them. You may need to chase down rent checks from some tenants, too, and you may have several months without rent checks when you're between tenants.
Tenants sometimes damage properties, and depending on local laws, they may be hard to get rid of. You'll be the one they call in the middle of the night if the roof is leaking, and you'll have to clean and perhaps freshen up the property between tenants. You can outsource much of this to a property management company, but it will take a cut of your income, often about 10%.
No. 6: Credit card rewards and cash back
Here's a far easier way to receive passive income: Use cash-back or rewards credit cards. (If you're carrying a lot of debt or don't have the discipline to use credit cards responsibly, you're best off not using this income-generation method.) You can collect flat-rate cash-back percentages up to about 2% with lots of cards, while some cards offer more focused rewards or cash back based on certain kinds of spending or certain retailers.
If you spend a lot at Amazon.com, for example, you can get a card that rewards you with 5% cash back on Amazon purchases -- which can really add up. Stores such as Target, Costco, Gap, Lowe's, TJX, and Wal-Mart also offer cards. Plenty of retailer cards offer 3% to 5% in cash back or discounted prices and many offer other perks, too, such as free shipping. If you travel a lot, travel-related credit cards can help you rack up lots of points and rewards that can be used instead of cash, keeping more cash in your pocket.
No. 7: Residual and royalty income
This passive income-generation method takes some upfront work, but then it might pay you well. You need to produce things that others can buy repeatedly, generating a stream of income that could last years.
For example, you might take photos and have them available for a fee at sites such as shutterstock.com, smugmug.com, 500px.com, or istockphoto.com. Similarly, you can create and upload designs at sites such as zazzle.com and cafepress.com, where people can buy them imprinted on shirts, mugs, and so on. Similarly, you might write an e-book and sell it online, perhaps via Amazon.com's direct publishing service.
No. 8: Affiliate marketing
If you have a blog or some other online property with some traffic, you can monetize it via affiliate advertising. For example, imagine that you write a blog about cars and you have thousands of visitors each month. You might review some books or products related to cars, and then link to them on Amazon so that you get a cut of the purchase price when anyone buys books through the links.
If you blog about travel, you might promote some recommended travel gadgets and accessories on your blog, again generating passive income if anyone buys any of it. You even might be able to link out to some travel companies' sites -- perhaps hotels or tour companies -- through affiliate programs.
No. 9: Annuities
Retirement is a time when most people need plenty of income. Stocks are great, but their growth or dividends aren't exactly guaranteed. If the stock market drops just before you were going to sell some of your holdings, you'll be stuck either liquidating more than you wanted to or settling for less cash.
A good option for many retirees and near-retirees is buying a fixed annuity (as opposed to variable or indexed annuities, which can have steep fees and overly restrictive terms). Annuity contracts are more generous when interest rates are higher, but here's how much income they might deliver at recent rates:
You also should consider a deferred annuity, sometimes known as longevity insurance, which will start to pay you at a future point. A 60-year-old man, for example, might spend $100,000 for an annuity that will start paying him $1,056 per month for the rest of his life, beginning at age 70.
No. 10: Refinance your mortgage -- or get a reverse mortgage
Another suggestion for passive income is refinancing your mortgage. Imagine, for example, that you're making monthly mortgage payments of $1,500 now and can reduce that to $1,200 per month by refinancing your home loan at a lower interest rate. That will let you keep $300 in your pocket each month. Of course, refinancing isn't free -- there are closing costs -- and you'll start the clock ticking on a new loan (typically of 15 or 30 years) when you refinance.
A related option, particularly for retirees or near retirees, is getting a reverse mortgage. It's not right for everyone, and the income it offers is tied to prevailing interest rates, which may not be favorable at some times. But it's still worth considering.
A reverse mortgage is essentially a loan where the amount borrowed doesn't need to be paid back until you die, sell your home, or stop living in it -- if you move to a nursing home, for example. At that time, the home can be sold to cover the debt, or your heirs can pay it off and keep the home. Reverse-mortgage income is often tax-free, which is another big plus. The amount you get can be delivered in monthly installments, providing very passive and reliable income in retirement.
Most people should find at least a few good ways to generate passive income -- cash you receive in exchange for little-to-no work -- from the list above. Know that it's not comprehensive, though. A little digging around or creative thinking can turn up even more possibilities.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Selena Maranjian owns shares of AbbVie, Amazon, Costco Wholesale, and National Grid. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Anheuser-Busch InBev NV, Costco Wholesale, Lowe's, National Grid, and The TJX Companies. The Motley Fool has a disclosure policy.