What is passive income and why is it important?

Posted on by in Categories:Investing, Tags:Tags

Passive income is anything that allows you to earn without having to do active work.

A good example is a savings account in a bank. When you open an account, the bank will accept your money and record it as your deposit.

At the end of each quarter, they give you interest. That interest is passive income. You are earning without really working. The only work that you did was to entrust your money to the bank. Nothing else.

The interest that you get may not be huge though. Most of the banks give 0.25% interest annually. And it’s taxable. Nonetheless, it’s an amount of money that you receive with you not having to do anything.

Another form of passive income is earnings from rentals.

If you own real estate property — such as a condo unit, lot, apartment, house, building or even a spare room — and you rent it out to other people, you can receive regular stream of money with little to no effort. Except maybe for the general upkeep of the property and collecting the rent.

But really, what you did was to allow people to use your property in exchange for a set amount every month.

However, real estate requires too much money.

Constructing an apartment needs a big investment. If you don’t have the needed capital, you end up borrowing from banks or Pag-IBIG.

Are there other sources of passive income that can have higher returns than savings accounts or that would not require very big upfront cost like real estate?

The answer is yes.

Benefits of passive income

By now, the benefits of passive income may already be apparent to you. Your earning doesn’t stop. You can get to increase your net worth even while you sleep.

Who wouldn’t want that?

1. Working smart rather than working hard.

Passive income allows you to live your life fully while you’re earning. It’s money that is working for you instead of you working for money. Which means you’re free to do the things that mean a lot to you.

You have more time to spend with your family.

You’re in a better position to focus on your work or business.

You get to hang out with your friends more.

2. Open multiple income streams.

Passive income makes it possible for you to make money from multiple sources. Wouldn’t that be nice?

This is especially true if you’re working or running a business. Aside from the dough you’re making from your active work, you can bring home more.

Also, you have a sort of cushion during unexpected events.

If you lose your job or your business goes down, your other income streams can help you tide over until you get back to your feet.

3. Meet financial goals faster.

You can meet your financial goals faster with passive income versus just relying on your salary alone.

You can obtain more funds more quickly with multiple income streams, meeting your financial goals faster.

You can go on your dream vacation earlier. You get to save up more and put up a down-payment for a brand new car or house in less time than it would take when you’re earning only from one source.

Risks

Now, you might wonder. It sounds too good to be true.

Well, there are things to bear in mind about passive income.

There is risk involved. But so is everything else. Having a savings account, for example. The risk you’re taking is having the bank be the custodian of your money.

But you still end up choosing to open a bank account because the benefits outweigh the risks involved. You don’t have to carry around large sum of money or safeguard it at home. The Philippine Deposit Insurance also lessens the risk by insuring up to half a million pesos worth of deposit.

The same thing goes with rental.

There’s risk that people won’t pay their due on time. Renters might vandalize or destroy your property. The location may be prone to flooding. New developments in the area, such as landfill or live poultry farm, could devalue its worth.

Bear in mind though that the lower the risks involved, the lower the potential return. That’s why savings accounts offer really small interest.

At the same time, the higher the risks, the higher the potential return can be.

But what are the risks involved?

First, there is risk that the capital might depreciate.

When you start taking part in managed funds that are into stocks, as we will discuss later on, there are times that the market might not perform well. It could lead to a decrease on the worth of your investments.

However, you’ll discover that there are ways to manage the risks. You might go for long-term planning, for example.

Second, there is risk that the potential return is not realized. Again, we will discuss ways on how to manage such risks, such as diversifying your investments.

Risk is everywhere, even with passive income. But there’s one thing you always need to remember.

You miss 100% of the shots you don’t take.