“Passive income” sounds like a scam because most of the time you hear about it on the internet, it probably is. If a fast-talking YouTube ad or 10,000-word blog post is asking you to buy their “system” making them 6-figures/month, it’s probably a scam. That’s just my gut.
If passive income was really as simple as buying an internet course, why would they be selling a course instead of just hiring workers to rake in more money with more products?
General rule: you cannot earn passive income if you’re starting from zero.
There are two broad paths to passive income:
- Build up a business until you can automate it (either through technology or hiring)
- Have a big chunk of cash and invest in something that will pay you. This is essentially the first step, but skipping to the end where you have a lot of money instead of the business itself
You probably won’t have the second (lots of money) until you’ve done the first (built a business). But I promised you passive income in the title, so let’s take a look.
4. Real Estate: Becoming a Landlord
The oldest trick in the book. Really, this is what medieval feudalism was based on: a lord lets peasants work his land in exchange for a portion of the crops they yield.
This old school system sucks because it’s almost entirely extortion. Peasants were generally unable to leave their hometown. In some places, the law actually forbade them from leaving. The landowner isn’t necessarily adding value because they can just sit on the property, do zero maintenance, and becoming a “landed” family was a status bequeathed by the crown so their local monopoly was protected.
The modern, free market version is much more equitable. Individuals are able to make choices about where they domicile. As a landlord, you can get a loan to buy a property, rent out the property (e.g. as an apartment) and collect income.
Need to know: Cap Rate
The most basic formula you need to calculate the return on an investment property is what’s called a capitalization rate, or cap rate for short.
It’s pretty simple.
(income from property – expenses from property) / property value
For example, let’s say:
- you’re bringing in $5000/year from a property
- it costs you $1000/year to run the place
- it’s worth $100,000 on the market to buy outright
The formula looks like (5000 – 1000) / 100,000 which equals .04.
Your cap rate is 4%.
That’s probably on the lower side of things (I just pulled those numbers out of nowhere for the sake of the example). Your cap rate is like ROI because it’s essentially what you’re getting out of the asset each year.
Getting a single snapshot of Cap Rate doesn’t take into consideration how the value of a property can appreciate or depreciate over time. Maybe rents go up faster than the housing market, or vice versa. This affects your rate.
Real estate is a beast of its own. But it’s the most common way the rich capture passive income, especially in retirement.
Rating how passive this is, where 1 is a full-time job and 10 is where it just deposits income into your bank, then being a landlord requires two ratings.
If you’re managing property yourself, I’d give this an 3/10 on passivity. You can make it more passive by getting good, steady tenants, but at the end of the day, they will call you when the pipes freeze in winter.
If you hire someone else to manage it for you, I’d bump it up to an 8/10. This certainly takes away from your profits, but also frees up your time.
3. Dividend & Blue Chip Stocks
This is what your great-grandma did. A dividend stock is one that pays you a tiny amount per share you own—from a few cents to a bit over dollar, generally.
“Blue chip” means a stock that’s from a legit company with steady income, which can weather recessions and depressions, and the company tends to issue dividends to its shareholders.
Some old folks used blue chip stocks as their entire retirement plan, expecting and living off the dividend. Grandma buys AT&T since she trusts it will be around forever, and as the population grows then so will its business. It’s not a speculation or high-growth stock, but it doesn’t need to be. She’s not trying to beat the market, just live off it.
This works for people who are not necessarily trying to grow their wealth, just live off it. I don’t want to do that. But it’s a “legit” passive income method so I’m mentioning it.
It’s also pretty much a 9 or 10/10 on the passive side of things. You just have to do intensive up-front research to make sure you’re picking a safe and steady dividend stock on the front end.
2. My Fave Passive Income Method: Writing Options
Also known as “theta gang” in the internet world. I definitely do not recommend this for someone unfamiliar with options. I also highly recommend you get familiar.
Options are the fastest way you can lose your money. So why would I recommend it? Disclaimer: I don’t, except for myself, so I’m letting you know what I’m doing.
Quick background: options give you the right to buy shares at a certain price. You can buy the right, or you can “write” or sell the right to someone else. You only do this when you own the shares to sell, or equivalent collateral.
How writing a call works
Let’s say I own 100 shares of GameStop because I eat crayons and love volatility. I bought them for an average price of $100 each (so $10,000 total). I can write one call on those shares, which I would do at a higher price than what I bought them for to make sure I don’t lose money.
So I write a call at $110—AKA give someone else the right to my shares if the price of the stock hits or passes $110. The call expires in two weeks. Because I sold them that right, I get paid a premium (let’s say the premium is worth $250). My risk is if the stock rockets $150, then I miss out on all those gains. I have to sell it at $110, even if it’s worth $250 or $500. BUT I still only bought it at $100, and 110-100 = 10, and 10 times 100 shares is $1000. So I gain $1000 from the sale, AND I gain the premium I initially earned of $250. My total gain is $1250.
If that all sounds like greek, that’s fine. This strategy isn’t for you (unless you go learn about it and take full responsibility for the risks you’re undertaking).
There are way more ways people use options and selling calls and puts and all that to earn money.
Depending on how much risk you can tolerate and how much you research your trades ahead of time, this can vary from 1/10 full-time job to an 8/10 easy checking and re-writing of your trades once a week.
It’s very low effort once you learn how it works, and I think looking at stocks is generally fun, so I actually like this method. But please, please don’t do this until you understand what the heck you’re doing.
1. One freaky weird passive income: BlockFi
BlockFi is a site where you can get trade and store your cryptocurrency. You can also get loans from it and lend it out. If you deposit cash, it earns 8.6% interest. That’s enough to beat inflation, so it’s not a bad passive income.
In terms of passivity, it’s 10/10. Transfer money and let it sit.
What are the risks? Not FDIC-insured and you’re earning in a cryptocurrency stablecoin instead of dollars directly. In my mind, that’s totally worth the risk. It’s not like dividend stocks are insured from falling, and it crushes any other savings account options out there. Think it through and make your own assessment.
If you’re interested, sign up through my link and see for yourself.
Last Word on Legitimate Passive Income
If you really want to make passive income, you have to start with a large chunk of money. If you want a large chunk of money (and not wait till you’re 40, 50, or 60) then you need to either be the best in your field at something, or start your own business.
Not everyone can be the best, but a lot more people can start their own business. And if you are the best, why wouldn’t you start your own business instead of giving someone else the fruits of your labor?
Disclaimer: I’m not responsible for your good or bad decisions because this isn’t investment advice (or I would be billing you). Be smart and own your choices.