Passive income investments often feel like the holy grail. Everyone loves the thought of being able to earn money without working, but finding genuinely passive investment opportunities that have a good ROI is challenging. Many times, the investments that involve more work (like running your own business, for example) have a worse return than those that require no effort on your own.
However, that’s not to say that there aren’t any opportunities. Here’s your guide to finding passive income investments that are worth the money!
Passive Income Definition
First, let’s define precisely what passive income investments are. The term passive income has two definitions. There’s what the term means and how the IRS views it. Sometimes, those don’t align quite as you would expect.
The core definition of passive income is that it is “earnings derived from a rental property, limited partnership, or another enterprise in which a person is not actively involved.” In other words, the term passive means that you have only contributed financially to the endeavor. You aren’t working for the money, which would make it an active income source.
However, the IRS views this term slightly differently. Most rental income is passive, even if you “work” on the home yourself. The only way in which rental income is not passive is if you are a real estate professional. The IRS also considers “trade or business activity in which you don’t materially participate during the year” to be passive income. So, if you write a check and make a couple of phone calls for a business, that’s passive income, but if you’re heading to the office regularly, it’s active.
Colloquially, when most people think of passive income investments, they’re thinking of the standard definition, not the IRS legalese.
Passive Income Investments That Are Worthwhile
Most people would love to find opportunities to earn money without needing to work for it actively. As such, passive income investments are highly sought-after.
Here are a few types of investments that you may wish to consider:
Owning rental property is by far the most common type of passive investment. Despite the perception, rental properties are not just for the wealthy, many middle-class people all over the world own a rental property and are using it to boost their overall net worth.
One of the attractive traits of rentals is that they have both a passive income stream in terms of the rents, but they also have a strong potential for capital appreciation. If you buy a rental in an in-demand area like Los Angeles or New York, you can almost guarantee that your property will increase in value in the long-run. For example, for many people, this means that they can secure a mortgage for $250,000 with 20% down ($50,000), have the tenants pay the mortgage off, and sell it for $500,000 30 years later. With capital appreciation, as long as the tenants pay the mortgage, owning rental property becomes an attractive investment.
Rental properties have a moderate average yield of 2-8%. However, what you make in real estate depends heavily on the area in which you invest.
Conventional Stocks, Bonds, And Savings Products
Your everyday bank account is a passive income source, technically. Many people invest in stocks that pay dividends passively as well as bonds, which also have passive interest payments. The average yield on these investments varies substantially, depending on the class of investment. Some stocks and bonds can yield 10% in dividends and interest alone. Bank accounts tend to give very little in terms of passive income – often ranging around 1% now at best.
P2P Lending (Average Yield 10-20%)
There are many sites online that offer P2P (peer-to-peer) lending. Two of the bigger ones are Lending Club and Prosper. In essence, instead of someone going to a bank and requesting a loan, they ask for one via one of these sites. The site calculates an interest rate and allows regular people to fund all or part of the loan. Instead of paying a big bank the interest rate, they pay the installment loan back to the people who supported it.
The attractiveness of P2P lending is that it provides a much higher return than some of the other investment options. The problem with P2P is that, since you are making a loan to a person, they can go bankrupt or walk away, and you might never see the money again. With a diverse enough portfolio, this becomes less of a problem.
Investing in smaller enterprises is also a way to earn money passively. To invest in non-publicly traded startups, you typically need to be an accredited investor. To obtain this designation, you must have a net worth of $1 million or an annual income of more than $200,000.
If you are an accredited investor, though, there are often significant opportunities to earn a fantastic ROI passively. Many startups and entrepreneurs are looking for funding through VC firms and angel investors. These opportunities can be as passive as you want, or if you desire to have a seat on the board of directors of one of the startups, you can ask for that as well.
Investing in startups is risky, but if you invest in the right one, the returns can be astronomical. Peter Thiel turned $500,000 into $638 million with his investment in Facebook. Once you add startups to your passive income investments, there are significantly more opportunities to make it big or lose quite a bit. You will also have to spend some time on due diligence, but once you make your investment, you needn’t be too hands-on after that if you set those terms upfront.
There Are Fantastic Passive Income Investments
Even though quality passive income investments might seem elusive, the reality is that there are many opportunities out there to earn money without working too hard for it. Rental properties, stock dividends, shares in startups, and P2P lending are all ways to make money passively. Many of these choices (like P2P lending and rentals) can have significant returns as well!