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MetaWealth
May 22, 2023
In today’s world of side hustles and more financial education than ever before, everybody seems to chase alternative sources of income and try to build them into something sustainable.
This is all great when it works out, but in order to make sure the effort you invest will pay off in the end, you need to understand what is passive income, how it works, how to tell if a side hustle’s earnings are passive or have the potential to become passive income or not, and so on.
In this full guide on what is passive income, we mean to cover all these topics and more, so you have the best start in learning how to turn your alternate sources of income - whether it’s passive or not - into a lucrative and growing safety net.
In today's fast-paced world, achieving financial independence and building wealth has become a common aspiration. Passive income has emerged as an effective means to attain these goals. But what exactly is passive income? Let's explore the concept, benefits, various strategies to generate passive income streams, how to calculate and optimize passive income, and what qualifies as passive income.
Passive income refers to the earnings generated with minimal effort or active involvement once the initial setup has been completed. Warren Buffett once famously said, "If you don't find a way to make money while you sleep, you will work until you die." Passive income allows you to do just that — earn money even when you're not actively working.
Typically, there is no true passive income from the start, unless you are inheriting wealth that is already self-sustaining. But if you’re building passive income streams from scratch, in the beginning each of these sources of earnings will require effort to set up and develop. In other worlds, they will not be truly passive in the beginning.
The trick is for you to be able to tell what is passive income, potentially, so that you can foresee whether a new side hustle you are starting will be able to produce money for you with minimal maintenance at some point, or whether it will require your hands-on involvement all the time. This is what today’s guide on what is passive income will aim to teach you.
There are numerous complex definitions of passive income out there, but before we get into technicalities, let’s keep it simple. What is passive income? It’s money earned with little to no effort required from the recipient of the income.
You can define passive income as the return on investment that continues to generate income after the initial work or capital has been put in. As Robert Kiyosaki wisely noted, "It's not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for."
Passive income can come from various sources, including rental properties, investments, and businesses where you have limited involvement. According to Investopedia, passive income can be defined as "earnings derived from a rental property, limited partnership, or other enterprise in which a person is not actively involved."
The Internal Revenue Service (IRS) also defines passive income as including earnings from rental properties or limited partnerships in which a taxpayer is not materially involved.
Passive income offers numerous benefits. It provides financial independence by diversifying income sources and reducing reliance on a traditional job. Mark Cuban wisely stated, "The ideal business is one that generates passive income whether you show up or not."
So, here are its most common benefits and the reasons why identifying potential avenues of passive income is so important for anyone who has the time, skills and budget necessary for it.
Passive income can provide financial freedom by diversifying income sources and reducing reliance on a traditional job. It allows individuals to have more control over their time and pursue other interests or ventures.
Passive income streams can be a powerful tool for building wealth. By reinvesting the earnings, you can accelerate the growth of your investments and increase your overall net worth.
Generating passive income provides flexibility in terms of time and location. Once the systems are set up, they can continue to generate income regardless of your physical location or the hours you work.
Are you interested in maybe making a career change even if it’s risky to become a junior in another field? Do you have any regrets about your career of choice and wish you would have taken another path?
That’s no problem at all as long as you have the safety net of a strong passive income source (ideally, multiple sources). The beauty of building a passive income is precisely that it can allow you to make the changes you feel you need at any point in your life, without being blocked by practical considerations (like I can’t afford to not work for the 6 months of training that this new career path requires).
With a nice portfolio and money coming in regularly, you can afford to take that plunge. Sky’s the limit!
The same goes for the power to say no to undesirable circumstances, like a job you no longer feel comfortable with, a boss you can’t handle anymore, or just a living arrangement you’d rather extricate yourself out of.
To wrap up this section, there are numerous benefits of passive income.
Passive income streams, the more numerous and diverse, the better, can be a powerful tool for building wealth. By reinvesting the earnings and taking advantage of compound interest (interest earned on the interest earned - kind of like a snowball effect for investments), you can accelerate the growth of your investments and increase your overall net worth.
To use another famous quote about passive income, this time by Tony Robbins, "The key to financial freedom and great wealth is a person's ability or skill to convert earned income into passive income and/or portfolio income."
Generating passive income also provides a flexible lifestyle. Once the systems are set up, they can continue to generate income regardless of your physical location or the hours you work.
We’re previously discussed in great detail what are the best passive income investments and how to get started to make passive income.
But all of these listed investment ideas (that you should totally check out if you’re looking for inspiration on where to start) fall into 5 big categories, based on their background strategy. Here are these main 5 buckets you can use to divide almost every passive income idea you may encounter.
Real estate is a popular avenue for generating passive income. Rental properties, real estate investment trusts (REITs), and real estate crowdfunding platforms offer opportunities to earn consistent rental income or capital appreciation. The only problem? It's expensive and complicated to get started with real estate investing.
MetaWealth offers you the chance to invest in real estate that generates true passive income in the form of rental earnings, with no paperwork and all the effort already made on your behalf, starting with just $100.
This is the beauty of tokenizing real estate, effectively democratizing access to wealth-building, by making the lucrative real estate assets available to people who wouldn't normally be able to invest in them.
Dividend stocks allow investors to earn a share of the company's profits on a regular basis. By investing in dividend-paying stocks or exchange-traded funds (ETFs), you can create a passive income stream through dividend payments.
Peer-to-peer lending platforms enable individuals to lend money to borrowers and earn interest on their investment. By carefully selecting borrowers and diversifying your loans, you can generate a steady stream of passive income.
In the digital age, creating and selling e-books, online courses, or software can be an excellent source of passive income. Once you develop and market these digital products, they can continue to generate revenue without constant maintenance.
Affiliate marketing involves promoting other people's products or services and earning a commission on each sale made through your referral. By building a website, blog, or social media presence, you can leverage affiliate marketing to generate passive income.
Let’s take a look at this cashflow quadrant, as it is known in the world of investing, separating your potential sources of income by the type of investment they need (time, money or employees).
As you can see above, most of these sources of income require you to invest time, or time and money, or time supervising what other people are doing to earn money. The only truly free type of income, what qualifies as passive income, is when you become an investor and use the money you already have to make more.
This is the mindset you should use for approaching all the passive income ideas you may encounter. These potential side hustles and investments need to be able, at least in the future, to make you more money with minimal effort on your side.
Passive income opportunities can vary in terms of their level of hands-on involvement and the degree of income generation. If you manage to set a nice side hustle for yourself and watch it grow into something that actually produces money, it’s easy to get enthusiastic about it, and you indeed deserve praise for your success.
But you’re only half-way there, even with a lucrative side hustle. The real question - and now we return to the fundamental inquiry about what is passive income - is whether your side hustle can stand the test of time if you gradually invest less and less effort into it.
This is the true endurance test and evaluation criteria that you need to apply to any side hustle idea you come up with. Ideally, before you have already invested a couple of years of your life in it.
If the way you make money on the side will always require you to work for it as hard as you did in the beginning, then you don’t have a passive income stream, you only have a hobby, or a side job.
There’s nothing wrong with having a hobby and / or monetizing it if that’s what you want to do, but for the purposes of building a strong passive income stream, this isn’t a success. And since you’re reading our guide for what is passive income, we’re pretty sure you want to differentiate between the side hustles that can earn you passive income and those that can’t.
It is essential to evaluate these opportunities correctly to determine whether they produce passive income or require active engagement. Let's explore some key factors to consider when assessing side hustles for their passive income potential.
When evaluating a side hustle, consider the amount of time and effort required upfront to set up the income stream. Passive income does involve an initial investment, but the goal is to minimize ongoing effort after the initial setup phase. Assess the time commitment needed to establish the income stream and determine if it aligns with your long-term passive income goals.
For example, creating and selling an online course may require significant effort initially to develop the course content and marketing materials. However, once the course is launched, it can generate passive income as students enroll and access the materials without constant involvement from the creator.
An important aspect of passive income is the ability to automate income generation processes. Consider whether the side hustle can be systematized and run on autopilot with minimal intervention. Look for opportunities that can be scaled without a linear increase in time and effort.
For instance, running an e-commerce business where you outsource order fulfillment and customer service can be more passive compared to a traditional brick-and-mortar retail business, which requires constant hands-on management.
Or developing a product that won’t cripple your production line if you suddenly enjoy a surge in orders. That would be, for example, the case of a virtual product like software or an app, that can scale almost instantly to more users without the developer’s equal scale-up in work time.
Passive income streams should ideally offer predictability and consistency in earnings. Evaluate the stability and reliability of the income generated by the side hustle.
Look for opportunities with recurring revenue models, such as membership subscriptions or royalties from intellectual property.
For instance, owning rental properties can provide reliable passive income through monthly rental payments. However, keep in mind that there may still be occasional maintenance or tenant-related tasks that require your attention, but as long as these are occasional it’s fine, your side hustle still counts as passive income.
Assess the scalability and growth potential of the side hustle to determine its passive income viability. Look for opportunities that can be expanded without proportionally increasing your time and effort.
For example, investing in fractional real estate through our app allows you to accumulate shares over time and benefit from compounding returns, as long as you reinvest the rental income you earn. As your portfolio grows, your passive income from the rent you are owed can increase without significant additional effort on your part.
Distinguish between side hustles that require active involvement and those that can be managed with passive monitoring. Active involvement implies direct participation, such as providing services or actively managing operations. That doesn’t sound too hands-free now, does it? Kind of defeats the purpose of what is passive income.
On the other hand, passive monitoring involves overseeing the income stream, but not being actively involved in day-to-day operations. For example, investing in a crowdfunded real estate project may require monitoring property performance and financial reports periodically, but it doesn't involve the hands-on responsibilities of property management.
Consider how technology and outsourcing can contribute to the passive income potential of a side hustle. Utilize automation tools, software, and platforms to streamline processes and reduce manual intervention.
Additionally, explore opportunities to outsource certain tasks or hire virtual assistants to handle administrative or operational responsibilities.
For instance, using email marketing software to automate the delivery of digital products or hiring a virtual assistant to manage customer inquiries can free up your time and make the income stream more passive.
When it comes to taxation, passive income is treated differently from other types of income.
Here's a breakdown of how passive income is typically taxed, at least for the U.S and most Western countries:
In general, ordinary income refers to earnings from active participation, such as salaries, wages, and self-employment income. This income is subject to progressive tax rates, where the tax rate increases as income levels rise.
On the other hand, passive income is derived from investments or business activities in which the taxpayer is not materially involved. It is often taxed at a different rate or may enjoy certain tax advantages.
Passive income derived from the sale of investments, such as stocks, real estate, or other capital assets held for more than one year, is typically subject to capital gains tax. Capital gains are classified as either short-term or long-term, depending on the holding period.
Long-term capital gains generally receive more favorable tax treatment with lower tax rates compared to short-term capital gains.
Passive income from rental properties is another common source of passive income. Rental income is generally subject to ordinary income tax rates.
However, rental property owners may be eligible for certain deductions, such as mortgage interest, property taxes, and depreciation, which can help reduce the overall taxable income.
This all depends on your exact country of residence, so you need to make sure you check in with your local tax office or authorities to figure out how much you need to pay from your MetaWealth rental income or any other rental income you may be entitled to.
The IRS has specific rules regarding passive activity losses (PALs). If your passive income from one activity is less than your passive losses from another activity, you may not be able to offset the losses against your other income. However, there are exceptions and limitations to these rules, so it's essential to consult a tax professional for guidance.
In the United States, the Tax Cuts and Jobs Act introduced a provision called the Qualified Business Income (QBI) deduction, which allows eligible taxpayers to deduct up to 20% of their qualified business income from certain pass-through entities, including partnerships, S corporations, and limited liability companies (LLCs).
This deduction can apply to certain types of passive income earned through qualifying businesses, subject to specific rules and limitations.
It's important to note that tax laws and regulations related to passive income can vary by jurisdiction. Different countries or states may have their own tax rules, deductions, and exemptions for passive income.
Therefore, it's advisable to consult with a tax professional or accountant who is familiar with the tax laws in your specific jurisdiction.
Passive income is a powerful tool for achieving financial independence and building wealth. It allows individuals to generate income with minimal effort and create systems that work for them even when they're not actively working. As Warren Buffett once said, "If you don't find a way to make money while you sleep, you will work until you die."
By understanding the concept of passive income and exploring various strategies, such as real estate investments, dividend stocks, peer-to-peer lending, digital products, and affiliate marketing, individuals can create multiple streams of passive income.
As Robert Kiyosaki once emphasized, "It's not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for."
The benefits of passive income are significant. It offers financial independence, the opportunity to build wealth, and a flexible lifestyle. Mark Cuban rightly pointed out that the ideal business is one that generates passive income whether you show up or not.
To optimize passive income, it is important to track and evaluate income sources, consider the initial time and effort investments, monitor and adjust investments, and leverage technology and outsourcing.
Incorporating passive income into your financial strategy can lead to a more secure and fulfilling future. As you explore the world of passive income, keep in mind the advice of Tony Robbins: "The key to financial freedom and great wealth is a person's ability or skill to convert earned income into passive income and/or portfolio income."
So, take action, diversify your income streams, and embark on the journey of building wealth through passive income. The possibilities are endless, and the rewards can be life-changing.
Extra resources on what is passive income and how to set yourself up for success:
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