Investing - 3 Common Passive Income Approaches to Build More Wealth

By Jeffrey Meenes, CFP® (Published Date September 22, 2022)

The idea behind Passive income is that it should be generated with little effort to maintain it. Generally, this type of income is tied to some form of risk-taking (investing). It allows for an accumulation of wealth without a person’s direct involvement once the initial investment has been funded.

Financial portfolios (stocks, bonds), rental properties, or private business investments are capable of generating regular cash flow. Each builds wealth using various tools from capital gains, interest payments, dividends, or limited partner shares. And of course, the Internal Revenue Service (IRS) comes into play with a guideline that defines passive income for tax purposes.

Some passive investments pay immediately, however, most gain momentum over time. You can build an investment portfolio to create a diverse source of short-term cash flow while accumulating long-term investments. As you dive into passive income investing, be sure you understand what’s involved.

3 COMMON TYPES OF PASSIVE INCOME

1. Investment Portfolios - Financial portfolios offer a variety of passive income ventures. Get your money working for you since you’ve spent a good portion of your life working to earn it. Stocks and bonds are proven over time to be good sources with high yields.

Once you've done the research, found the stock, and purchased shares, now you have to wait for them to perform. You'll need to monitor performance periodically. The concept is to earn more money than you invested and if the stocks increase in value, you can sell for a profit.

• Do the research and buy performers (income earners).
• Select a productive and in-demand market segment with growth potential.

Buying bonds is a form of lending money in exchange for scheduled interest payments. Bonds mature over time, and the issuer must repay your principal investment at maturity. Do the research, since all investments have some level of risk. 

• Purchase bonds from proven sources preventing any loss of your investment.

Annuities are insurance products that pay passive income monthly. There are precautions due to high fees or upfront costs, but there may be  some benefits.

• Lifetime income streams or cash payouts aligned with schedules.

2. Rental Properties - Real estate continues to be a high-interest investment for passive income and substantial tax deductions to offset the tax liabilities. Single residential dwellings, townhouses, condominiums, or apartment buildings (multiple units) could be used for generating steady income.

Most serious investors hire property managers or landlords to maintain the property. Their job is to keep the property in good condition (building equity), keep units occupied, and manage rental agreements, or tenant issues.

Tax benefits allow the owner (investor) to deduct the cost of these services, mortgage loan interest and property taxes against the revenue (rent) collected without having to participate in the daily upkeep. 

3. Private Business - Consider investing in a business by providing capital. Become a limited partner, and sit back, while the developer or entrepreneur works on generating passive income for you. The relationship between an investor and limited partner is linked to the amount of funding and the percentage of earnings. Usually, there’s a written agreement (contract) with the terms and conditions. 

Technology has created massive opportunities for passive income with online apps, eBooks, services, and other products. You invest in the project for a portion of the earnings or royalties produced from each sale and collect passive income.  It’s a fact more and more business is being conducted online.

Depending upon the structure of the business, your investment could pay dividends on a regular basis.

Although passive income may not involve daily management or business involvement, it does require time and energy for research and analysis about the market and the business risk.  Look for cash flow and growth prospects without real-time involvement.

If you are considering opportunities for generating passive income, it's always a good idea to work with a financial advisor. They can answer your questions and provide helpful advice on-going. A qualified financial advisor can also help with  the upfront checks and balances involved with choosing productive passive income investments.