How to Generate Passive Income
We all should desire to increase our passive income. The benefit of passive income is that it can grow beyond your individual ability to earn income. Additionally, once you establish passive income streams, they will continue to produce revenue with minimal oversight and input. Essentially, you can start “earning money in your sleep,” making traditionally non-productive hours productive. Do not let this cliché fool you into thinking that passive income is a get rich scheme. There are a few types of passive income that we will focus on; while these strategies are not novel, they will produce consistent results.
What is passive income?
Passive income is revenue you earn with minimal effort to sustain the income. In other words, once the source of income is established, it will continue to earn money without active input from you. Generally, passive income relies on the principle that it takes money to make money. In other words, there will be an initial investment to establish the revenue streams. Here are the three types of passive income we will discuss:
- Stock dividends
- High-yield savings accounts
- Real estate rentals
Stock Dividends
Not all stocks pay dividends, but if you wish to establish passive income, look for stocks that have a history of dividend growth. Stocks are certificates of ownership. When you purchase a stock, you then become a partial owner in the company. Dividends are the distributions paid to the stockholders. Generally, these dividend payments will occur quarterly (every three months). The payments are based on the annual dividend yield paid out over these regular intervals. For example, in 2023, Coca-Cola paid an annual dividend of $1.84. This dividend was paid out over four quarterly payments of $0.46 each.
Dividend Reinvestment
If you have dividend-paying stocks and want to take your passive income earning potential to the next level, you should also consider a dividend reinvestment program (DRIP). When you enroll a stock in DRIP, you receive several benefits. For instance, you obtain the potential to purchase fractional shares. When you purchase shares of stock, you are generally limited to buying full shares. However, when you utilize DRIP, you can purchase a fraction of a share. To understand why this is important, consider if you had 40 shares of a stock valued at $40 per share. If you are enrolled in DRIP, and the quarterly dividend is $15, this $15 will buy you an additional 0.375 shares (almost half a share). This fractional share will then start earning dividends, so the next quarter you will earn dividends on 40.375 shares. As a result, you benefit from compounding interest. The dividends you earned the previous quarter start producing their own dividends. The true power of compound interest comes over time. If you repeat this compounding process over a decade or multiple decades, the results are impressive. Additionally, over this time, the stock should appreciate (assuming the investment was made in a solid company), so not only will you receive the dividends, but the shares you own will also have a greater value.
High-Yield Savings Account
In addition to stock dividends, you can also earn money on your money without investing in anything. The way to do this is to utilize a high-yield savings account. If you currently have your money in a traditional savings account, I highly recommend transferring it to a high-yield savings account. A high-yield savings account can pay interest rates that are over 25 times higher than a standard savings account. The interest rates vary over time based on inflation and the interest rate established by the Federal Reserve, but typically, they are similar to the rate paid by certificates of deposit (CDs). The primary difference between a high-yield savings account and a CD is that your high-yield savings account interest rate is not fixed, rather it can vary from month to month. Additionally, you can withdraw money at any time from your high-yield savings account without penalty. The interest you earn from your high-yield savings account will also compound and accrue interest. To provide some perspective on the value of high-yield savings accounts, the majority were paying just over 4% interest in late 2023. In contrast, a traditional savings account was paying between 0.01% to 0.10%.
Real Estate Rentals
While buying dividend stocks and opening a high-yield savings account are simple steps that anyone can take to earn passive income, the real estate market has a higher barrier to entry. The reason for this is that the initial real estate investment can be substantial, depending on your location. While you can start buying dividend shares and utilizing a high-yield savings account with under $100, you will likely need to save a down payment to purchase your rental property. Once you purchase the rental property, there will be ongoing operating expenses, such as repairs, taxes, and potentially a property manager. However, once you own the property, the growth can potentially occur much faster than some of the other passive income streams. Your main source of income with be the monthly rent from the tenant; however, the value of the property should also appreciate. Therefore, if you rent a property for 10 years that you purchased for $150,000, you can expect to sell it for substantially more. The rate at which it appreciates will largely depend on the location. Certain states and certain areas of the country with high expected growth rates will typically appreciate at a faster rate. One of the benefits of real estate is that it is tangible. You will always have the land and buildings on the land.
Conclusion
There are numerous opportunities to generate passive income. If you want to start generating passive income immediately, consider purchasing dividend stocks and enroll those stocks in DRIP. Additionally, transfer your traditional savings to a high-yield savings account. Both of these actions can be done with a minimal amount of money and will result in compounding growth. Real estate rentals also provide passive income and can be very enticing; however, the barrier to entry is a little greater.
