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Passive income is a cash stream that requires little or no daily effort to maintain, unlike active income, such as cash earned from working at a job or as a contractor.
You can create passive income through investing in certain financial products or by starting businesses that, after an initial investment, start to generate income without regular work. The taxes you'll pay on passive income may vary depending on the source of the money, so make sure you keep careful records of your earnings.
Here are some of the most common ways that investors can earn passive income.
1. Dividend stocks
One way to build an income stream is to invest in dividend stocks, which distribute part of the company’s earnings to investors on a regular basis, such as quarterly. The best ones increase their payout over time, helping grow future income.
Dividend stocks typically are less volatile than growth stocks and help diversify your portfolio. Investors can also choose to reinvest dividends (learn more about dividends and how they work).
» Learn more: 25 high-dividend stocks and how to invest in them
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2. Dividend index funds and exchange-traded funds
You can also invest in index funds or exchange-traded funds that hold dividend stocks rather than picking and choosing individual stocks to buy.
This is a form of passive investing for those who prefer a more hands-off approach.
Index funds hold a well-rounded selection of many stocks that aim to mirror the performance of a given index, such as the S&P 500. A dividend index fund will invest in a selection of stocks that pay dividends. Index funds can help balance portfolio risk, as market swings tend to be less volatile across an index compared with individual stocks.
Dividend ETFs offer the diversification benefits of index funds while mimicking the ease with which stocks are traded. To invest in dividend stocks, index funds, ETFs or other publicly traded assets, you’ll need to open a brokerage account if you don’t already have one.
» Learn more: Index funds — how to invest and best funds to choose
3. Bonds and bond index funds
Rather than buy an ownership stake in a company through stock, bonds are a way for investors to lend money to companies — as well as federal, state and local governments — and collect interest income. Bonds are considered a safer investment than stocks, but also generally earn a lower return on your investment. For example, from 1926 to 2017, government bonds earned a compound annual return of 5.5%. An index of large stocks earned 10.2% during the same period, according to Morningstar research.
Experts suggest investing a portion of your portfolio in bonds because of their lower volatility and relative safety compared to stocks, then having a higher ratio of bonds in your portfolio the closer you are to retirement.
» Learn more: How to buy bonds
4. High-yield savings accounts
Another way to earn passive income (albeit at a lower level than stocks and bonds) is a high-yield online savings account, which can be ideal for growing your emergency fund. The interest paid by savings accounts is added to your balance.
High-yield accounts are a type of federally insured savings account that earns an interest rate that’s often much higher than the national average. The APY of these high-yield accounts may vary slightly, and over time, those small differences add up to real cash, so it pays to shop around for where you put your savings.
» Learn more: Best high-yield online savings accounts
5. Rental properties
Purchasing properties to earn rental income is another way to build passive income. Long-term rentals can provide a reliable source of cash if they are located in a healthy market for renters, but they also carry long-term stressors like maintaining those properties, as well as paying multiple mortgages, property tax bills and other costs.
You could also focus on short-term rentals through a platform like Airbnb, which is dependent on a steady flow of visitors to your area. Or, start small: Rent out a room in your house to begin to bankroll your rental property empire.
» Learn more: How to invest in real estate — 5 ways to get started
6. Peer-to-peer lending
Real estate investments are long-term bets to build passive income. If you want to potentially earn income and cash out your investment in under five years, one tactic to consider is peer-to-peer lending.
An alternative to traditional bank loans, peer-to-peer lenders, like Prosper and Lending Club, match investors who are willing to lend money with borrowers who are vetted by the platforms for creditworthiness. It’s riskier than putting cash in a high-yield savings account or money market fund, but also potentially can earn more interest — as much as 5% or more.
7. Private equity
Perhaps the original form of peer-to-peer lending, another common form of passive income is funding a private business you believe has the opportunity to generate future income. For high-net-worth individuals, this might be investing in private equity funds, which are typically only available to accredited investors who meet certain net worth or income requirements.
Another way is to back a family member, friend or other trusted partner to help fund their business with an agreement to earn returns from any future profits. But beware: No matter how large or small, investing in a single business is an inherently risky, long-term bet. Never invest more than you can afford to lose.
A way to build passive income at home is through payments for the use of intellectual property that you have created yourself, or for which you've purchased the rights.
Creating content can be a lot of work, especially for work that is engaging and reaches a large enough audience to generate income.
But once you've created something that people are using, it’s possible to generate revenue through display advertising, using a program such as Google Adsense, or to run sponsored content, which means companies pay you a fee to publish a post on your blog.
Another way to monetize a blog is affiliate marketing, which allows you to earn commissions if your readers purchase a product or service you’ve recommended or linked to. You may, however, find that creating content is not as hands-off as you might expect; there's always pressure to create more content or update what you have to keep it viable.
» Learn more: How to make money from blogging
9. Real estate investment trusts (REITs)
If you want to build passive income from real estate without the fuss and bother (not to mention the hefty down payment) of buying and managing properties yourself, REITs may be the answer.
Similar to mutual funds, REITs are companies that own commercial real estate, such as office buildings, retail spaces, apartments and hotels. REITs tend to pay high dividends, but they vary in complexity and availability. Some are publicly traded on stock exchanges; others are not.
» Learn more: REITs — what they are and how to invest in them
New investors may want to stick to publicly traded REITs, which you can purchase through an online broker.
10. Crypto staking
Crypto staking is a way of growing your holdings in certain cryptocurrencies by using them to help verify activity on an underlying blockchain network. When you stake a cryptocurrency, you can be rewarded with more cryptocurrency.
Staking, for most people, involves delegating your cryptocurrency to someone who is compiling records of transactions on the network on which it runs. Those verifiers need to put some tokens at stake to guard against fraudulent transmissions. By giving the voting power of your tokens to a reputable verifier, you can get a share of the rewards they receive for carrying out their job accurately.
But there is some risk: If the verifier you're working with is penalized, you may be as well. And staking sometimes requires you to commit your holdings for a set period of time, meaning you can't sell or trade them.
It's important to note that staking is not available on all cryptocurrencies — notably Bitcoin does not support staking. But several crypto platforms have other rewards programs that offer interest on cryptocurrencies through activities such as lending.
» Earn with crypto: Best crypto staking and rewards platforms
Disclosure: Author Andy Rosen held no positions in the aforementioned investments at the time of publication. NerdWallet is not recommending or advising readers to buy or sell any investment.