Passive Income: What Is It, Sources, Benefits, and How to Build It?

Passive Income: What Is It, Sources, Benefits, and How to Build It?


Legendary investor Warren Buffett is well known for his financial quotes. Let us list two of his quotes. He said: "If you don't find a way to make money while you sleep, you will work until you die". He also said: "Never depend on a single income. Make investment to create a second source".

In both quotes, Warren Buffett emphasises the importance of passive income and the need to have it. In this article, we will discuss what passive income is, its benefits, sources, and how to build it.

 

In the first quote, Warren Buffett says you should invest a portion of your active income. The invested money then generates income on it. The income generated can be a one-time lumpsum (capital gain), recurring income (passive income), or a combination of both. For example, equity investments can give you recurring income (dividends) and lumpsum (capital gain on sale/redemption).

 

He says if you don't have investments that generate income, you will be dependent on your active income. To earn active income, you have to keep working.

 

Hence, Warren Buffett says that if you depend on active income, you will have to keep working till you die.

 

In the second quote, Warren Buffett says never to depend on a single source of income (specifically, active income). What if you lose your job suddenly? Hence, you should invest and create a second source or multiple sources of income (preferably recurring sources of income or passive income).

What Is Passive Income?

Passive income is that source of income that keeps coming to you regularly. The frequency of income may vary: monthly, quarterly, yearly, or something else. Passive income generation usually requires a one-time set-up effort or a one-time set-up effort with low recurring effort. 

With passive income, there is no ongoing fulltime involvement as it happens in your job to earn active income. One important financial goal for most people is to create an asset or a corpus that could become their alternate source of income. 

One-Time Effort

Investing in certain financial assets and generating regular passive income requires a one-time effort. For example, opening a fixed deposit and generating monthly passive income through monthly interest requires a one-time effort. 

You need to set up the FD online or visit the bank branch once. Once the FD has been opened, the bank keeps crediting the FD interest amount in your savings account every month on a specified date.

Similarly, you can invest in shares or equity mutual funds and generate regular passive income through dividends. The frequency of dividends and the amount depends on the company's financial performance.

One-Time Set-up Effort With Low Recurring Effort

Investing in certain assets and generating regular passive income requires a one-time set-up effort and low recurring effort. For example, you can buy a residential property and give it on rent to generate monthly passive income. Here, you need to make a one-time set-up effort to purchase the property. It also requires regular maintenance, which is a low recurring effort.

Another example and a popular method of generating income is by way of a SWP (Systematic Withdrawal Plan) from your Mutual Fund investments. SWP is essentially an instruction to withdraw a fixed amount from your investments at regular intervals (generally monthly). It is tax efficient and a very effective income generation tool.

Building Passive Income: Starts Slow, Grows With Time, and Makes a Significant Difference

When you start building your passive income, in the initial stages, it will form a very small part of your overall income portfolio. For example, you invest a specified amount regularly in the shares of a dividend-paying company or a bank fixed deposit. After the first few years, the dividend income or interest income will form a small portion (say around 5% or even less) of your overall income.

As you continue investing regularly through the years, in the medium term, the number of shares in your portfolio will increase. As the company grows and the financial performance improves, the dividend per share will also increase over the years. At this stage (5-10 years), the passive income (dividend income) will form a decent portion of your overall income.

In the long term, as you continue investing, the number of shares in your portfolio and the dividend per share will grow significantly. In the distant future, you may reach a stage where the passive income equals your active income or even surpass it. However, you need the discipline of regular investments and the patience of time for it to happen. But, if you are determined, slowly and surely, you can do it.

Ways to Make Passive Income

In India, there are many ways in which you can earn passive income. Infact, it is a good idea to work on more than one source of passive income. If one or a couple of passive income sources fail or don't generate the amount of income you want, you can drop them and focus on the ones working well. 

Some of the sources of passive income include the following.

  • Bank fixed deposits can give you interest income. You can choose the interest payment frequency to be monthly, quarterly, half-yearly, yearly, etc.
  • Government bonds or corporate bonds that pay interest at a specified frequency
  • Equity shares and mutual funds can give you regular dividends. However, the frequency of the dividend and its growth depends on the company’s financial performance
  • Systematic Withdrawal Plans: An SWP is an effective method of creating a regular stream of income from the corpus that has been created in a Mutual Fund. Given its advantage of being tax efficient, it is a very popular income generation tool
  • Real estate property (residential and commercial) can give you monthly rental income. Purchasing a property requires a huge financial commitment and is not everyone’s cup of tea. For smaller investments, you can consider fractional real estate or purchase shares of a stock exchange-listed real estate investment trust (REIT). As per SEBI guidelines, REITs make quarterly distributions.
  • Infrastructure Investment Trust (InvIT) shares can be bought from the stock exchange. Like REITs, they make quarterly distributions.
  • Alternative investments like peer-to-peer (P2P) lending, asset lease financing, structured debt instruments (SDIs), etc., are seeing keen interest from retail investors as passive income sources.  However, understand the risks involved in alternative investments before investing in them.
  • Affiliate marketing that involves sale of various products and services of various companies through blogs, websites, and various social media platforms. The payment is made on a per sale basis.
  • Advertising income through Google Ads and direct advertisements on blogs, websites, etc.
  • Income from selling various courses or e-books through own website, blog, and various third-party platforms
  • Earning income from online opportunities such as e-commerce, blogging, YouTube videos, Instagram reels, podcasts, online sessions, etc.
  • Earning royalty from book sales
  • Referral income from the sale of various products and services. In this case, members/subscribers who join through you get mapped to your referral code. Whenever they pay for a
  • product/service, you get paid referral income

The above are just some sources of passive income. You will come across many more passive income sources on the internet.

Benefits of Passive Income

Some of the benefits of passive income include the following.

Low Investment

Most passive income sources, except for financial investment sources (FD, shares, real estate, etc.), require low investment. For example, if you want to do affiliate marketing, earn advertising income from a website or earn referral income, etc., it requires a very low investment.

Flexible Working Hours

Passive income opportunities provide you the much-needed flexibility in terms of when you want to work on them, how much time you want to devote, etc. You can pursue them with your active job after working hours or at weekends. With passive income, there are no geographical restrictions. You can earn passive income from anywhere.

Supplements Active Income

Passive income can supplement your active income. It can reduce financial stress if your active income is not fully meeting your current expenses or not leaving enough savings for investing. The additional passive income can help you improve or upgrade your lifestyle. It can fulfil your short-term financial goals or invest towards achieving your long-term financial goals.

Freedom to Pursue Your Passion

If your passive income is significant or more than your active income, it can help you quit your active job and pursue your passion. It gives you time and money to enjoy life by spending time with family, taking up your hobby or learning a new skill, doing social service, working on your dream project, travelling to your favourite destinations, etc.

Passive Income Can Give You Financial Freedom

Most people start with active income as their primary source of income. You can save and invest some part of your active income to start generating passive income. With time, as your active income grows, you can increase your investment towards passive income annually. With regular disciplined investments, over time, passive income will start becoming a significant part of your overall income. If you persist, it will exceed your active income. When that happens, you can switch entirely to passive income as it can give you financial freedom and pursue your passion.

Passive income is powerful. It can make your money work for you and generate income while you are relaxing at a beach on a family vacation!

 

What Is Passive Income Benefits of Passive Income Ways to Make Passive Income

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