Passive Income

Passive income is the secret to retirement, in a nutshell it means that you are earning money without trading your own time for it, so you are free to enjoy life, without actually working to earn that money coming in every week.

There are a number of factors you need to think about when it comes to passive income, however one of the most important is when to start creating these systems that generate wealth, and what are the best ones for you at this time.

It is never too early in life to have a passive income source, and they are certainly not only for the elderly and mega rich, however the time isn’t always right to embark on one, and the economic climate does impact your choices quite a lot.

When NOT to set up passive income vehicles

• If you have Credit Card Debt, Car Loans, Personal Loans – CLEAR THESE OFF ASAP!
• When you have existing Debt that is with a variable rate tied to Interest Rates. If you have a long term debt that is fixed, such as Student Loans or Mortgages, you can have them locked in at a low rate – right now in 2012 there are great rates out there and if you can secure something now that doesn’t move, then in a couple of years, if the rates increase you can benefit from keeping a running debt and putting money into savings that earn more than the rate you borrowed at.
• When you haven’t set aside sufficient short term savings – these are high liquidity (Savings/ Money Market Accounts, and 90 Day CDs will work here)

When to set up passive income vehicles

• When you have set up a comfortable short term nest egg for your emergency fund, debts are under control and you have a little disposable income.
• At any age you have the above covered.

Passive Income Chart

Types of Passive Income Sources

Investment Property

Pros – Stable Asset Class (if you monitor the market), long term history of appreciation, good Tax incentives, Medium Risk

Cons – Can require effort, and you will have to raise costs by hiring a management company etc in order to make this income passive.  Tenants can be troublesome, Maintenance costs can be a nasty surprise when problems occur.

Bonds

Treasury Bonds

Pros – Stable, Long Term Guaranteed rate of return. Low Risk

Cons – Small Growth/Return compared to other vehicles due to the low risk and current low interest rates.

Muni Bonds

Muni bonds are issued by your Municipality or State 

Pros

1. If you purchase Bonds issued by your State of Residence they are exempt from local taxes, EG in NYS they are called Triple Tax Free where you avoid tax on income from City, State and Federal Levels.  If you purchase another state you always get the Federal exemption, but not the local levels.
2. Muni Bonds can pay higher rates of return than Treasury Bonds

Cons

There is some concern on the financial health of the individual State, and with high debt ratios at this time there is a lot high chance of Default than with the more stable Treasury Bond – Medium Risk.

Certificates of Deposit (CDs)

Pros – Guaranteed rate of return for life of CD, flexible terms/length of CD. TIP – Look out for intro rates from Credit Unions, you can get upto 4% on CDs even in todays market, where the high st banks are offering less than 1%.

Cons – Money is locked up for the duration of the CD, and interest is taxible.

Dividend Stocks

Pros – Dividend Interest is currently taxed at a much lower rate than personal income tax, ask Mitt Romney about this one!

Cons- They are still tied to the market, and there is a lot of volatility here at the moment.  If you pick a stock that cuts its dividend you may be subject to a knee jerk reaction that impacts your underlying stock value with overselling, and hurting your retirement hopes.

Royalties – Books, Music, Software

This is one of the best examples of a true passive income.  A book takes some time to create, but once written, everytime someone purchases it that is income for nothing in your pocket.  With the growth of E-Readers books are a lot more accessible these days and income potential very high.

Blogging

Included here, as you can get some passive income, but in reality you need to keep the blog fresh with new information which is a job, so its not a great option in my mind.

There are many other Passive Income vehicles out there, and I will cover them further in the future.  It is worth noting with everything that is Investing Diversity is critical.  Many of the ways that you can earn money are linked directly to economic indicators, so you need balance within them in order to weather the changes in the market.

My advice as ever, is to start with clearing down those bad debts, then get started building your mix of Passive Income sources.