How to Generate Passive Income

Last Updated: October 16, 2021 References

Some people define passive income as money you earn while sitting on a beach sipping a good drink. But don't let the word "passive" mislead you, because there is usually a lot of upfront work involved. Passive or residual income is money you earn while not being actively involved after an initial investment of time and/or money. Some methods require you to have some cash to spend initially, while other ideas don't require any spending at all. Here are some suggestions on how you too can generate passive income.

Method 1

Method 1 of 3:

Investing in Dividend-Earning Securities

1
Decide to invest in dividend stocks. Dividend stocks pay out a portion of the company's profits to shareholders. These dividends are paid at regular intervals, so they produce a regular income stream. Investors who hold a large amount of this type of stock are known as "income investors" because they prioritize regular dividends over stock value growth.^{[1]
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- Dividends do not necessarily lower the risk associated with investing in the stock market.
- Before choosing this strategy, be warned that dividends are taxed as income rather than as capital gains, meaning that the taxes you pay on them will be higher than what you would pay on another type of market investment.^{[2]
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2
Choose stocks with high dividends. Typically, the companies that pay the highest dividends are older, more established companies. These companies no longer need to reinvest their income into growing the company, so they are free to allocate the money to investors in the form of dividends. Telecommunication companies, Real Estate Investments Trusts (REITs), and utility companies, in particular, are known for having high dividend payouts.^{[3]
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- Always check a company's stock price performance and fundamental stability before investing in them. High dividend payments are great, but only if the company paying them survives.^{[4]
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- In other words, look for very old, established companies that have been paying dividends at roughly the same or an increasing rate for a long time.
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3
Calculate dividend yield. Dividend yield can help you calculate the return you'll receive from your dividend-earning stock. It is calculated by simply dividing the annual dividend payout per share by the price per share.

So, a stock that costs $50 and returns $3 in dividends each year would have a dividend yield of $3/$50, or 6 percent. This would be a great dividend yield, as the average company on the S&P 500 returns 2-3 percent.^{[5]
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Reinvest your earnings. You can grow your portfolio even more by reinvesting your dividends. This means that when you receive a dividend payment, instead of keeping the money, you use it to purchase more shares in the company.^{[6]
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Consider doing this every time you receive a dividend until you need to live on the passive returns (perhaps at retirement). Your equity and in turn your dividend payments will continue to build during this time.
5
Invest in bonds. When you purchase a bond, you are purchasing a loan taken out by a company or a government. The bond issuer holds your money (the price you paid for the bond) for a defined period of time.

You receive fixed interest payments, usually twice per year until the term of the bond expires. When the bond expires, the bond issuer pays you back the principal.

Bonds are a good option for passive income because they take little time to manage and you can start earning money quickly.

That said, bond prices are at a point now where their values will decline significantly if and when interest rates go up. This means that your returns on bonds purchased now may be very low when you actual receive your payments.^{[7]
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Method 2

Method 2 of 3:

Earning Royalties

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Invest in resource royalty trusts. Royalty trusts are investment vehicles provided by major banks that provide royalty payments from the extraction of natural resources, like coal and natural gas.

The trust itself has no involvement in the mining or production of these materials, but earns regular royalty payments that are then distributed to shareholders. The exact royalty payment depends on the volume of resource sales and the market price of the resources, but investors are seeing high yields, sometime higher than 10 percent.^{[8]
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In addition, these investments are taxed like capital gains rather than as income (like dividends) and may qualify you for energy-based tax credits.^{[9]
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Before investing, be aware that this is still a volatile investment. Payments are liable to change without warning and, eventually, the natural resource will be depleted, ending payments entirely.

Additionally, shareholders over a certain threshold may be liable for additional state income taxes in the state where the trust is held.^{[10]
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2
Buy entertainment royalties. Royalties are typically paid to the holders on intellectual property for the use of that property. The property can be anything from literature and music to patents on inventions. These royalties can be earned by creating a valuable idea and licensing that idea out.

However, other investors can also purchase the rights to these royalties from their creators. This allows the creator to partially or entirely sell their rights to a property, giving them a lump-sum payout and an investor the rights to receive steady royalty payments.

Search for royalty exchange websites online to get started. Notable websites include SongVest and The Royalty Exchange.^{[11]
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3
Participate in royalty-based venture financing. In traditional venture financing, an investor buys a stake in a company to provide growth capital to its founders. This investor is then entitled to a percentage of the gains experienced when a company is bought or has an initial public offering.

However, there is another kind of venture financing where an investor can invest start-up capital in exchange for regular royalty payments that are based on the company's revenue.

This doesn't give the investor any ownership in the company, but does guarantee regular payouts (assuming the company survives). This type of investment is rare and will have to be negotiate with the business owner.
4
Buy shares in royalty companies. In addition to royalty trusts, there are also royalty companies that exist apart from financial institutions. These entities finance mining operations in exchange for royalty payments on the value of minerals and precious metals mined. These companies can also sell shares in the market, allowing investors to enjoy their royalty benefits.

Well-established royalty companies can also provide stable income, as many have diversified their holding in a variety of mining operations, guaranteeing relative stability from market fluctuations.^{[12]
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Shares of these companies generally trade at about 20 times royalty. That means that the return on investment would be about 5 percent per year.^{[13]
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Method 3

Method 3 of 3:

Investing as a Silent Partner

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Understand what a silent partner does. In short, the silent partner is an investor in a business partnership who does nothing except provide their capital. This type of investor, also known as a "limited partner," has no hand in the daily operations of the business. They are limited in liability to the amount of their investment, meaning that they could lose their investment, but not more.

This type of investment provides passive income with the potential to be quite large if the company grows. However, there is no guarantee that the other partners will follow through on the promised growth.^{[14]
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Always consult with a lawyer before investing a silent partner. This will help you understand your legal and financial obligations to the company.
2
Find business partners. In order to be a silent partner, you will need active partners to grow and maintain the business. Usually, these are either friends or family members looking for a way to get their business idea off the ground.

Other times, you may be able to seek out small business owners looking for investors. In either case, investigate the other partners and determine whether or not they are trustworthy and business-savvy enough to grow their proposed company.
3
Go over business proposals. Being a silent partner is not a completely inactive position.

You can still review business proposals and usually have the right to vote on important company matters. Before investing or deciding on a large growth push, review the company's financial projections and business plans.

Calculate the potential returns you could earn versus how much you stand to lose if the venture fails.
4
Structure your partnership. Limited partnerships can only be created by filling out official documents with your state. In many cases, you'll have to draw up a formal partnership agreement that determines each partner's rights, responsibilities, and percentage ownership, among other important details.^{[15]
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Even if you are not required to do this, you should anyway to avoid any conflicts in the future. As usual, always discuss this contract with a lawyer before signing it to make sure that you are being treated fairly in the agreement.