How to Make Passive Income

in this guide

What is passive income?
Active versus passive income
Passive income ideas
Don’t forget about taxes

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What is passive income?

Passive income describes a cash flow that takes minimal time and effort to maintain, like money generated from investments, properties or side hustles. The goal is to achieve a steady flow of cash without the daily commitment of a full-time job.

However, what qualifies as passive income isn’t always straightforward. Some see interest and dividends as the only “true” passive cash streams. Others believe income earned from property is hands-off enough to count.

Active versus passive income

Having more than one source of income can help you feel more financially secure. One way to achieve this is by adding a passive income stream to your active income.

Passive income differs from active income, which is money you earn from working, like salary, tips, commissions or fees. Setting up passive income usually involves investing money, time or effort upfront. The goal is that you’ll eventually start receiving a cash stream with little or no ongoing input. Active income, on the other hand, stops if you stop working.

However, depending on your passive income source, it might take years to provide a return, and the amount you earn may be inconsistent.

Passive income ideas

Many people invest in financial assets for extra income, but you can also get started by creating an asset or sharing something you already have. Here are some common passive income ideas to consider.

1. Dividends

Dividends are regular payments a company makes to share profits with its stockholders. Dividend payments are not guaranteed, and the value of your underlying investment can go up or down.

There are a few ways to earn dividends.

Buy shares of a company. Investors often buy shares in companies with a track record of paying dividends for regular income. Dividends represent a share of the company’s profits, and ASX-listed companies typically pay them twice a year. In Australia, companies can choose to distribute franked or unfranked dividends. Fully franked dividends have tax credits attached to them; you may be able to use these credits to lower your overall tax bill, depending on your situation.
Invest in a managed fund. Another investment option with dividend or income potential is a managed fund. This is where you pool your money with other investors, and the investment manager buys and sells assets on everyone’s behalf. Managed funds can have different objectives: exchange-traded funds might aim to mimic the returns of an index or commodity; a single-asset fund may focus on a specific type of asset, like cash, shares or bonds.
Real estate investment trusts (REITs). REITs allow investors interested in the commercial property sector an opportunity to receive income without becoming a landlord.

2. Interest

Savings accounts, term deposits, government bonds or corporate bonds are generally lower-risk options that can also provide steady and predictable income.

Many savings accounts offer a base rate and a bonus rate. It’s often a good idea to read the fine print to understand if there are conditions you have to meet — like minimum deposit amounts and a maximum number of withdrawals — to qualify for the bonus interest. The government’s Financial Claims Scheme also protects deposits of up to $250,000 per person.

Term deposits offer a guaranteed rate of interest on money that you agree to lock away for a set length of time.

Investing in bonds involves lending money to the government or a company, which is responsible for paying you regular interest until the bond matures. Corporate bonds tend to offer better interest because their default risk is higher.

Nerdy Tip: Savings accounts tend to be safer, but they’ll also provide a smaller return. If the interest rate on your savings account is lower than the inflation rate, you could be losing money in real terms.

3. Property

Another popular passive income strategy is to rent out an investment property either as a long-term rental or short-term holiday let.

There are usually significant upfront costs involved and ongoing maintenance to consider, and it’s not always possible to charge enough rent to cover those expenses. Many investors lighten the workload by outsourcing their management and maintenance responsibilities.

You could leverage tax breaks to offset rental income with eligible expenses, including paying mortgage interest if you took out a loan to buy the investment property. If you hold the investment property for at least a year before selling it, you could get a 50% discount on the capital gain.

4. Marketplace or peer-to-peer (P2P) lending

As an alternative to investing in government and corporate bonds, you can lend to everyday borrowers through a P2P lending marketplace. Generally, P2P lending offers greater flexibility and a higher return than traditional savings products.

A P2P lender operates an online platform to link up borrowers and investors. The borrower makes regular payments, and the operator passes them on to you. Some operators allow you to choose between lending to an individual or a business, while others let you invest in a portfolio of loans.

P2P operators screen borrowers for repayment capacity and lending risk. Even though they’re required to act responsibly to keep their Australian Financial Services (AFS) licence, platform operators can’t guarantee you’ll get your money back. P2P loans are typically unsecured, and they have no government protection.

In addition to lending platforms, online marketplaces also offer opportunities to make money by sharing something you have. For example, you can rent out a spare room if you own your own home, or rent out your car if you’re not using it. If you live centrally and have a garage or car parking space, you could lease it to people who work nearby. Whatever you choose to rent out, check the implications for any relevant insurance policies.

6. Low-input business

If you’re happy to put in a small amount of time and effort, starting a low-input business — like a laundromat or a vending machine — could be a low-stress way to earn steady returns.

7. Content creation

These days, it’s possible to turn your knowledge, skills and hobbies into paid content. For example, you could write an ebook or create an online course or other digital products for users to buy. You could also license original photos if you’re a keen photographer.

Successful bloggers often monetise their websites by charging a fee in return for companies advertising on their blogs. They might also receive commissions for recommending or linking products if their readers buy them.

Since you don’t need a lot of financial resources to start creating, content can be a highly competitive space, with a lot of work necessary to maintain the visibility of your website or blog.

Don’t forget about taxes

You’ll need to bear tax in mind with all of these passive income ideas, especially as some of them could have both income and capital gains tax consequences. Be sure to keep careful records so you can declare the right amount of income and claim all allowable deductions. Generally, you’re required to retain supporting documents for tax returns for five years.