A beginner's guide to passive income

Making money without even trying might sound too good to be true — but there are ways to do it. Unlike the "active" income you earn from, say, your 9-to-5 job, "passive" income is a stream of cash that flows without regular work on your part. 

But before you jump in and start buying up apartments to rent or dividend stocks, it's important to understand everything that passive income entails. Some sources are more passive than others, and there are tax implications to consider.

What is passive income?

Passive income is money you make "without a large amount of additional work added to your day-to-day routine," said Kiplinger. Examples of passive income include dividends earned from stocks, income from a rental property and royalties from an e-book you published. 

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The aim of passive income is to generate an additional source of income alongside the money you're bringing in from your job and other places. Doing so can "help you to grow your savings and increase cash flow," Kiplinger said.

What to know before setting up a passive income stream

You'll want to start by being realistic about how much time, effort and money you want to sink into your passive income project. 

Typically, you will need "startup capital" to get your passive income endeavors off the ground, said Investopedia. "To develop a meaningful passive income stream from financial assets like cash-equivalents, stocks and bonds, you'll need a decent account balance." That said, there are some passive income streams that require a type of initial investment that isn't necessarily monetary, such as talent or time.

When determining which passive income stream is a good fit for you, it is also helpful to assess what skillsets you already have. Do you already have experience with investing? Do you know how to create online content or courses? By zeroing in an area in which you already have some knowledge and experience, you can cut down on the time involved. 

But regardless of your familiarity with your chosen income stream, you'll likely need to put in some time at the outset to get the ball rolling. The amount of time involved will vary depending on your chosen method. For instance, opening a high-yield savings account or a certificate of deposit (CD) only takes a bit of research up front, plus some time invested in opening the account. Real estate investing, meanwhile, can be far from passive.

It's also important to realistically assess the risk involved. Some passive income endeavors are riskier than others, and you'll want to ensure you are only taking on as much risk as you're comfortable with. For example, if you create a course that flops, your only loss would be the time it took for you to make it. But if you buy a potential rental property that ends up needing extensive repairs, that presents a much higher level of financial risk.

And last but certainly not least, you will want to factor taxes into the equation. Usually "net income from passive income investments is reported as ordinary income," said Good Financial Cents, with the exception of capital gains income. 

4 passive income ideas to consider

Now that you've read up on the basics of passive income, you can start thinking of some ways to earn it. Here are four of the most reliable sources of passive income.

Dividend investments

This can include dividend stocks as well as dividend index funds and exchange-traded funds (ETFs). In either case, you'll get a regular payout of a portion of a company's profits. However, income is not guaranteed; companies may have to decrease dividends or could become unable to pay them.

To get started, you'll need to open a brokerage account. Also note that "you likely will have to tie up thousands, if not tens or hundreds of thousands, of dollars to earn significant income from dividend stocks," said Forbes.

Bonds and bond index funds

Bonds allow investors to lend money to companies, as opposed to taking an ownership stake like they would when investing in stocks. Investors will then earn interest income.

For those who are more risk-averse, such as individuals approaching retirement, bonds can be a safer bet "because of their lower volatility and relative safety compared to stocks," said NerdWallet. However, they will also "generally earn a lower return on your investment." 

High-yield savings accounts or CDs

The trick to making investing in a high-yield CD or savings account a solid stream of passive income is to search for the top rates. Often, you'll find those at online banks.

Plus, said Bankrate, "investing in a CD or savings account is about as safe a return as you can find." The downside is that returns might not be as impressive.

REITs

While your initial instinct might be to invest in physical real estate to generate investment income, that can come with a lot of headaches and more time investment than you may want. An alternative way to earn passive income through real estate is by investing in a real estate investment trust (REIT).

REITs "own and manage income-producing properties and distribute the profits to investors," said Good Financial Cents. In some cases, you may need to be an accredited investor, though other platforms make real estate investing more accessible.