Money earned from a single investment that yields recurring profits without any ongoing management on the part of the investor is said to be passive income. While the Internal Revenue Service (IRS) treats active and passive income similarly for tax purposes, there are some important differences. For example, one can cancel out passive benefits by utilizing passive losses.
In addition to the tax benefits, many people are interested in generating passive money from sources like working from home or doing side gigs that require little time commitment.
Being a limited partner in a partnership is one strategy for generating passive money. Those in the general public, however, have alternative options for putting their savings to work.
The passive investment methods discussed further below are deserving of your attention.
1. Real Estate
Real estate is still the best option for investors seeking long-term profits, notwithstanding its recent ups and downs in price. Particularly, apartment building owners can benefit from having rental properties. The investor can buy a home with only a 20% down payment and fill it with reliable tenants to ensure a steady stream of income.
Real estate investment trusts (REITs) are a good choice for people who don’t want to take care of rental properties. 90% of a REIT’s taxable income is given back to investors in the form of dividends.
On the other hand, dividends are taxed like regular income, which could be a problem for investors who are in higher tax brackets.
Crowdfunding for real estate is a way to find a happy medium. Investors can choose to buy commercial or residential properties with their own money or by taking out loans. Unlike REITs, crowdfunding gives investors the tax benefits of direct ownership, like the depreciation deduction, without the added responsibilities of property ownership.
2. Peer-to-Peer Lending
Even though the peer-to-peer lending (P2P) industry (also known as crowdfunding) has only been around for a little more than a decade, it has grown by leaps and bounds. It is the act of lending money directly to a person or business. Lenders and borrowers connect through online platforms like Prosper and LendingClub. Returns are usually between 7% and 12%, and the investor doesn’t have to do much after making the loan.
Most P2P programs are easier to get into than other kinds of investments. For example, investors can use as little as $25 to help pay for loans. Title III of the Jumpstart Our Business Startups (JOBS) Act lets both accredited and non-accredited investors invest through crowdfunding, but each P2P platform has its own rules for how to join.
3. Dividend Stocks
Stocks that pay out dividends are one of the easiest ways for investors to make money without doing anything. As public companies make money, some of that money is taken out and given back to investors in the form of dividends. Investors can choose to keep the money or put it back into more shares.
Dividend yields can be very different from one company to the next and from one year to the next. If an investor isn’t sure which dividend-paying stocks to buy, they should stick with the ones that are called “dividend aristocrats.” This means that the company has been paying out large dividends for at least 25 years.
4. Index Funds
These are exchange-traded funds or mutual funds that follow a certain market index. These investments aim to replicate the results of their benchmark. Management of them is very hands-off. Because of this, the underlying securities don’t change unless the index changes. For investors, this means lower management costs and lower turnover rates, which makes them more tax-efficient than many other investments.
Questions to Ask Yourself Before Investing in a Passive Income Strategy
Earnings from sources in which the recipient does not actively participate are known as “passive income” and can come from, for example, rental properties, limited partnerships, or other businesses. This means that these investments can be made with a carefree “set it and forget it” attitude. Nonetheless, even “passive” investments sometimes need some kind of management or monitoring.
Let’s look at the real estate market. The investment property needs regular upkeep, and any problems with the tenants need to be fixed. Many cities have ordinances requiring landlords to carry certain types of insurance and install various safety features.
Even passive index investing requires some management, as the relative portfolio weights will need to be changed and rebalanced over time when individual stocks within an index experience gains or losses. Each investor must decide for themselves how often or when rebalancing should occur.
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