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There are three main types of income classifications: portfolio, active, and passive income. Money received from capital gains, from stocks, bonds, dividends and interest is considered portfolio income. Active income is generated from wages and any endeavor that requires ongoing, active participation on the part of the recipient. Income that is passive is a type of income that once setup, requires no further input from the recipient. Music, movie, television, book and screenplay royalties, patent royalties, rental income, click-through income, and online advertising revenue are just some examples of different types of passive income.
Undertakings that generate passive income typically require a substantial investment at the outset, either of time, money or both. Financial routes to nonactive income can include buying rental property or investing in a company or partnership where you do not play an active role. Income from such investments is considered passive.
Other forms of passive income require very little or no financial investment, but might take considerable time and effort to create. Whether penning a novel or building a popular website that will be able to generate income through advertising, it’s not unusual to invest a year or more of intense work paving a road to income passivity. And it can take even longer to turn a profit.
In the case of books, for example, publishers recoup advances paid to authors along with printing costs before royalties are generated. If a book does not sell well, it might not make the author money at all. For websites, the challenge is in creating not only good content, but also in achieving high placement in search engine returns in order to generate the amount of traffic required to be successful. Without substantial traffic, passive income will be minimal to non-existent.
The attraction to investing so much time in a task with so little guarantee, is that if successful, the venture can generate money seven days a week, 24 hours a day, for years to come. Whether vacationing in the Bahamas, at home grocery shopping, lying asleep at night, or at work on the next project, passive income is always being generated. Once a project is self-sufficient, the entrepreneur can start another, ideally creating several streams of income, building a substantial yearly revenue that allows maximum freedom. Unfortunately, passive income is taxable in the United States.
Icecream17- I agree with you, but I prefer to invest in municipal bonds. Municipal bonds offer tax free income for the life of the bond.
For example, a bond offering a yield of 5% on one million dollars yields $50,000 in tax free income per year. Payments are usually made twice a year.
Mutual funds that pay dividends are great but you do have to pay capital gains taxes on those dividends while you don’t pay any taxes on municipal bonds.
Most investors can begin investing in municipal bonds with just $25,000. AAA general obligation bonds are best.
Great article- I just want to add that many people who seek passive income understand that there is only so much income that can be derived from daily work because there are only so many hours in a day. For this reason many people seek passive income.
The easiest way to obtain passive income is from dividend yielding mutual funds. Mutual funds that yield a dividend can automatically reinvest in the fund or you can elect to receive the income directly.
But if you continually make deposits to the account the compounding nature of the account will grow significantly over time. Many people use this strategy for retirement.
Many people use income generated from their mutual funds or stocks at retirement to live off of and some never have to touch the original contribution.