For many people, their ultimate dream is to have the freedom to pursue their passion or hobbies all day while being sustained by the “magic” of passive income. But the reality is that generating passive income requires effort too.
Earning income from passive investments usually begins with saving a portion of your working wages to invest. And that takes discipline and hard work. But if you choose the right investments for those savings, they could truly “make you money while you sleep” for years to come.
Best investments for passive income
Some look at passive income streams as a means of supplementing their working income so they can cut back their hours and spend more time with family. Others may hope to replace their day-job income altogether so that they can retire early.
Whatever your reasons for pursuing passive income, earning solid returns with the least amount of ongoing effort is the underlying goal. With that in mind, here are the best investments for passive income in 2020.
1. Dividend stocks and funds
One reason that dividend investing is at the top of our list of best investments for passive income is that it allows you to earn income on a stock you own regardless of its price movement.
For example, Johnson and Johnson currently pays a quarterly dividend of $1.01 per share ($4.04 per year). With 100 shares, you’d earn $404 per year in dividend income alone. For buy-and-hold investors, that’s a nice chunk of change to earn while you wait for the stock price to (hopefully) increase over time.
If you’re looking to get started with dividend investing, you may want to start with the Dividend Aristocrats. These are a select group of companies that have increased their dividend every year for at least 25 years.
Once you’ve decided which stocks you want to buy, you’ll want to find a stockbroker that doesn’t charge trade commissions Ally Invest, TD Ameritrade, E*TRADE and You Invest by J.P. Morgan are a few of our favorites.
If you only have a small amount of money to invest, you may want to consider buying fractional shares of dividend stocks. In many cases, you’ll earn a fraction of the dividend, as well. Or, if you’d prefer to avoid the hassle of picking specific stocks, you could buy shares of a mutual fund or exchange-traded fund (ETF) that invests in dividend companies.
2. Rental properties
There are multiple ways to earn passive income with investment properties. The most hands-off option would probably be to become a traditional landlord. If you screen your tenants well, the only time you hear from them may be when they’re delivering your monthly rent check.
But while short-term rentals like Airbnb typically require more work, there are ways to make them more passive. For example, my parents own an Airbnb property in a completely different state and pay a management service to run it for them.
Buying your first rental property will require a larger upfront investment than some of the other ideas on this list. But it’s also one of the only ideas that could earn you $500 to $1,000 (or more) of monthly income from Day 1.
3. Index mutual funds and ETFs
When John Bogle at Vanguard unveiled the first index fund in 1976, he began an investing revolution. Since they passively track stock market benchmarks instead of being actively managed by fund managers, index funds and ETFs charge remarkably low expense ratios.
But low expenses doesn’t mean low returns. Actually, the opposite is usually the case. According to SPIVA, which stands for S&P Indices versus Active, over the last 5 years, actively managed funds underperformed on the S&P 500 77.79% of the time. The average annual return is about 10%.
Index funds and ETFs may be the ultimate “set it and forget it” investment as most stockbrokers make it easy to invest the same amount of money in them each month. Or you could use a robo-advisor like M1 Finance, Betterment, or Wealthfront to build a custom portfolio of low-cost ETFs that match your risk profile.
Related: These Are the Best Robo-Advisors
4. REITS and real estate crowdfunding
You don’t have to be a landlord to earn passive income on real estate. With Real Estate Investment Trusts (REITs) and real estate crowdfunding, you can buy little pieces of commercial and private property investments.
A REIT is a company that invests in commercial, income-producing real estate. Public REITs sell on stock exchanges like mutual funds and ETFs and are typically very liquid. You can get started with investing in a public REIT after opening an account with a stockbroker.
Publicly-traded REITs aren’t your only option if you’d like to pool your resources with other real estate investors. Other options include private (non-SEC-registered) REITs, public non-traded REITs, and real estate crowdfunding.
Some of our favorite places to build passive real estate investment income include Fundrise, EquityMultiple, and RealtyMogul. And if you’re an accredited investor, you may also want to consider Crowdstreet and PeerStreet.
5. Peer-to-peer lending
Peer-to-peer lending platforms bring individual investors and borrowers together. Typically, borrowers turn to P2P platforms in search of more lenient credit requirements. Investors, on the other hand, are looking for above-average returns on their money.
Fees are usually more reasonable with P2P platforms as there is no financial institution serving as the “middle man.” Also, you’ll typically have the opportunity to choose the credit rating of the borrower who will receive your funds. The lower you’re willing to go, the higher the interest rate you could receive, although also the greater your risk.
But even the “safest” loans on P2P platforms should net you a much higher yield than a bank account. For example, as of this writing, LendingClub is offering rates that range from 6.46% to 17.74%. On a $10,000 loan, that would earn you $646 to $1,774 of purely passive income.
6. Bonds and bond funds
Bonds are another way to earn passive income by lending out your money. But while your money usually goes to an individual with P2P lending, bonds are typically issued by companies or federal and state governments.
While they haven’t historically performed as well as stocks, bonds are still one of the best investments for passive income because of the safety they provide. Treasury bonds, specifically, are one of the lowest-risk investments available to investors today.
You don’t have to buy individual bonds to get involved with bond investing. Many mutual funds and ETFs that invest in bonds are available today. The Fidelity Total Bond Fund, for example, has a 30-day yield of 1.69% as of this writing.
7. High-yield savings accounts
High-yield savings accounts may be the best investments for passive income if you don’t want to risk losing any of your principal. At FDIC-member banks, the federal government insures your deposits up to $250,000 per account.
With most other types of passive income investments, your starting balance could go up or down. But with savings accounts, your initial deposit is guaranteed. And that’s a big deal, especially if you’ll need to use the money within the next 5 years.
Saving account yields have taken a hit over the past few months in response to a near-0 Fed rate. That’s why it’s more important than ever to search for accounts that offer above-average yields. These are some of our favorite high-yield accounts available right now:
8. CD ladders
A certificate of deposit (CD) requires savers to keep their money in the account for a specific period of time (often a few months to several years). In exchange, these accounts offer fixed interest rates that are often higher than the typical savings account.
Despite their benefits, some savers avoid CDs because they don’t want all their money tied up for a long period of time or they worry that interest rates may rise in the future. A CD ladder, however, can reduce these downside concerns.
With a CD ladder, you separate your investment into multiple CDs with varying maturity dates. For example, $10,000 could be split in this way:
- 12-Month CD: $2,000
- 24-Month CD: $2,000
- 36-Month CD: $2,000
- 48-Month CD: $2,000
- 60-Month CD: $2,000
In this way, you can take advantage of the higher passive income offered by longer-term CDs while having the flexibility to withdraw some cash on an annual basis. Check out our Best CD Rates to make sure that you’re building your CD ladder with the best yields available right now.
9. Private equity financing
Directly investing in companies through private equity financing is one of the best investments for passive income if you’re comfortable with taking bigger chances. If the company grows by leaps and bounds, you could enjoy amazing returns while someone else handles all the day-to-day work.
However, private equity financing is also riskier than some of the other investments on this list. If the company goes belly up, you could earn $0 profit and lose your principal to boot. Also, private equity funds are often only open to accredited investors.
If you do happen to meet the income or net worth requirements to be an accredited investor, private equity investments could well be worth considering. Otherwise, you could still get involved in private equity investing by becoming a silent partner in the business of a family or friend that you believe in.
10. Online content marketing
Creating helpful and informative online content through blogs, podcasts, or YouTube videos can be a great way to create passive income. There are various ways to monetize your content including display advertising, sponsored content, and affiliate marketing
The great part about content creation is that once you’ve created it, your work is (mostly) done. In some cases, you could earn passive income for years on a piece of content that only took you a few hours to produce.
The content marketing world is competitive, however, so you’ll need a solid plan for building traffic. For starters, you could check out our guide: How To Start a Blog and Earn Extra Money.
Passive income is money earned from a source other than your employer, self-run small business, or any other endeavor that would require your daily involvement and effort.
With the exception of investments that are held inside a tax-advantaged account like an IRA, 401(k), or self-directed IRA, most passive income will be subject to federal and state income taxes. The specific tax rates will depend on the type of investment and how long it’s been held.
Since interest and dividends aren’t considered earned income by the IRS, most passive income sources won’t affect your eligibility for unemployment benefits. And as long as managing investment properties isn’t your primary job, you should be able to exclude rental income from your reported wages as well.
If you only have a small amount of available money to invest, some of the best investments for passive income include high-yield savings accounts, CDs, index funds, and dividend stocks. As your net worth grows, you may consider branching into other passive income investments like rental properties, REITs and real estate crowdfunding, and private equity financing.
While it’s more difficult to generate passive income with no money, it’s not impossible. The most common way to accomplish this is by selling digital products, courses, or photos online. Digital content can often be produced for free and then sold repeatedly without any ongoing effort from the creator. In this way, they can be a great way to build passive income without any cash leaving your own pocket.
While earning passive income takes discipline and hard work, the right investments can help you reach your financial goals a bit quicker than you may have thought.