What Is Passive Income?

There’s no hotter buzzword in today’s personal finance and investment world nowadays than ‘passive income’. Describing it is one thing; recounting success stories of people who seem to be making money out of thin air is yet another; but the hardest part about passive income seems to be its very definition. We’ve compiled a guide to this elusive concept, complete with the many ways to define it, tips from some industry greats, and an actionable strategy for the would-be investor hoping to accumulate passive income.

Passive income definition

Before we delve into the definitions below, it’s important to understand what passive income is not. No matter how seductive this view may seem to the uninitiated, passive income is not ‘raking in the cash, while you sip Margaritas on some beach in the Bahamas’. In other words, there is no legal, ethical, or legitimate way to make money, either online or off, without some form of upfront investment, be it money, time, and/or effort. Now, on to the definitions of passive income:

  • Wikipedia relates passive income to the closely linked concept of unearned income. The latter is understood as any kind of windfall: welfare, inheritances, pensions, property income, financial assets, and profit from capital income equipment ownership. The former can include income made from those activities, but also has the distinctive characteristic of coming in on a regular basis, with some (but not too much) effort required to maintain it. Unlike, of course, nonpassive (or active) income, such as the one you earn from a regular job.
  • The American Internal Revenue Service only recognizes two sources for passive income: –     property rentals; and
  • trade or business activities which don’t require the material participation of the income earner.

It’s worth mentioning that the IRS tests for material participation vs non-material participation by using the several simple rules. If you’ve put 500 hours or more into an activity; if you’ve put in at least 100 hours, and that’s at least as much as anyone else involved; or if you’ve put in most of the participation in a business activity for a specific tax year, the IRS will consider it material participation.

Also, for the record, though passive income is taxable and also taxed by the IRS, losses on passive activity are eligible for deduction offsets. These deductions are received over the course of the following tax year and are applied in a way that takes earnings and/or losses for the following years into account.

Passive enables you to not work when at old agesThis is why you want passive income. Because no one wants to work well into their old age.Image source: imgur.com

  • Finally, Investopedia takes a close view to the one upheld by the IRS, in which passive income is derived from enterprises in which the income earner is not materially involved, including, but not limited to, rental property and limited partnership. The online resource also allows for stock and dividend portfolios to be included among sources of passive income. It also allows for be-your-own-boss and work-from-home income earning activities to be classified as passive income (among others), yet it does stipulate that the IRS takes a divergent view to this.

So, now that we’ve established the framework for this discussion, and also previously determined the distinction of residual versus passive income, let us take a closer look at what earning passive income entails. For the purposes of the following discussion, we’ll be focusing on online passive income investments, with a work-from-home schedule. And we’ll be lending our ears to one of the greats.

3 Smart Passive Income ideas from Pat Flynn

Don’t know who this Pat Flynn guy is? If you’re at all serious about generating passive income, then he’s the man you should be getting your first tips from. In 2014, the now 32 year-old webtrepreneur was profiled by prestigious financial mag Forbes, who was really curious how this regular looking dad and husband had made his first $3 million. It’s an impressive tale, to say the least—and a highly relatable one, too. In 2007, the then architect lost his $38k/year job and in October 2008 he started a blog to help him prepare for the notoriously difficult architecture industry exam LEED (Leadership in Energy and Environmental Design). By the end of that year, the blog had earned him $38,000. He went on by adding AdWords ads to the site, wrote and sold an eBook, and, eight years later, he can boast with over 100,000 email subscribers, 9.5 million downloads of his passive income podcast, not to mention at least $2.7 million more in the bank than when he first started out.

Pat Flynn - Smart Passive Income

Image source: SmartPassiveIncome.com

Smart Passive Income pro tip #1: You can earn $100,000 from 1 site, or $1,000 from 100 sites – both approaches are just as valid

It all depends on the investment school of thought you subscribe to. In brief, here are the respective philosophies behind these two approaches:

  • A diverse portfolio is a safer portfolio. Invest in as many products as your brand will allow you, to keep your investment as safe as you can. Or, in the words of folk wisdom: “don’t lay all your eggs in one basket.”
  • Keep your personal brand clean. If you belong to that special breed which mixes the attitude of an entrepreneur with the capital of an investor, you might want to be more selective about the products you associate with. As such, you may choose to only invest in a handful, not a hundred.

Smart Passive Income pro tip #2: Online income still comes from link juice

In other words, whether you choose to build a money-making website yourself, or have someone do that for you, with your money, you will want to pay good attention to back links. Never, under any circumstances, should you underestimate the power of a good back link profile and accompanying strategy. Here’s what works in this respect (and is not likely to change anywhere in the near future):

  • Back links are still the ‘heaviest’ element in the algorithm.
  • It’s all about how good your back links are (i.e. how high the authority of the site leading back to yours), not how many you’ve got.
  • Aside from authority, relevance is the next essential factor. In other words, you should try to score links from sites in matching, similar, or relevant niches to the one where you’re active.
  • Though the jury is still out on what the golden ratio is, you’re going to want to go in for anchor text diversity: URL anchors, branded anchors, and non-branded anchors should all feature in your back link profile.
  • Finally, if you haven’t already, take this opportunity to forget all about: link blasts, e-zine links, article directories, link schemes, and anything remotely similar.

Evolution of Pat Flynn's IncomeThat’s the evolution of Pat Flynn’s passive income over the past six and a half years.

Image source: Forbes.com

Smart Passive Income pro tip #3: The riches are in the niches

Though it’s been over-used, the following piece of wisdom bears repeating: there is no life for a search engine result that ranks beyond page 2. In other words, if you do manage to get your website to rank on page for a highly competitive keyword like ‘apple smartphones’, good on you. Here’s a pat on the back—because that’s likely all the compensation you’ll be getting for your titanic efforts.

If, on the other hand, you manage to rank first for a keyword that gets a couple of thousand (heck, even a couple of hundred is great!) searches per month, you’re golden. Here are a couple of rules of thumb for ranking for the right keywords:

  • Try keywords with at least 1,000-3,000 searches. This kind of search volume will ensure a relatively steady stream of income, once you do manage to get your site to the top of the SERPs.
  • Assess keyword difficulty by looking at the competition. Is there room for you to rank? Check out you keywords: how authoritative are the pages already ranking there? Do they feature the keyword in the title of the page and/or Google snippet? How many back links to they have? What about Page Authority, mozRank, Page Rank, anchor text diversity, and quality of content?
  • Finally, see how much money you stand to make from this niche, by checking out the average Google Adwords CPC. Bear in mind that your website will only be earning you a percentage of that amount. By and large, the higher the CPC, the better—because it signals that advertisers are engaged in bidding wars against one another. Also, it’s a good idea to check out Amazon, for products relevant to the niche your keywords belong to, since you might consider joining their affiliate marketing program.

A 4-stage strategy to cashing in on online passive income opportunities

1. Be prepared for a lot of upfront effort in the initial stages

Example 1: Pat Flynn of SmartPassiveIncome used to work 80 to 100 hour work-weeks when he first started building his first project, Green Exam Academy. It took him about 18 months to grow an audience—until then, he was rather literally stabbing (or typing, if you will) in the dark.

Example 2: Later in his life and career Apple Inc. founder Steve Jobs became known as a sort of modern-day enlightened spirit, filled with Zen musings and bliss. However, it’s no secret to his inner circle (or to anyone who has ever worked directly with him) that Jobs was a hard worker to the point of obsession. Among other things, he is quoted to have said,

Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do.

Example 3: Hugely successful casual game developers Rovio, who have bestowed the gift of Angry Birds on the world had to release 51 other relatively unknown games, before making it big with this one title.

The takeaway: You’ve heard all the clichés before, and we’re only here to tell them that they’re all true. Work hard, play harder, strive to keep a fair balance between your work and your personal life, and always try to make your own luck. But, at the end of the day, know that you have worked hard, and will likely continue to work very hard, until you catch that one big break. If you choose to invest your money in online passive income generating websites, getting that initial capital is going to require effort. But that effort is bound to pay off, after all is said and done.

This is how a million dollar business looks like these daysThis is how a multi-million dollar business looks these days.

Image source: ytimg.com

2. Choose your market with your heart, too, not just your wallet

For this one, we’re going to let some all-time entrepreneurship greats take the floor and talk to you about motivation, business ethics, and the value of passion. In a day and age where most investment opportunities come with a fair degree of risk, it’s perhaps wiser even for an online investor to think of herself as an entrepreneur. Not in the sense that you’ll be setting out to build a corporation, but in that you want to master their kind of attitude.

Why? Because both have to start with a significant capital of both cash and confidence, both will be taking some risks, and, ultimately, both need to choose their field of investment as one that is close to their heart. In this sense, investing in the Internet is one of the best possible forms of investment, because it’s a system that still has the power to change the world, by connecting individuals and delivering them free access to a repository of all knowledge.

Quote 1:

“My biggest motivation? Just to keep challenging myself. I see life almost like one long University education that I never had — everyday I’m learning something new.” Richard Branson

Known as an innovator, Branson founded his first enterprise (a magazine called Student) at the tender age of 16. He went on to run a record company from a church, sign on bands no one else would (cue the Sex Pistols), and eventually started a galatic travel company. Throughout it all, he kept investing in the cutting edge, the controversial, and the very young.

Quote 2:

“When you find an idea that you just can’t stop thinking about, that’s probably a good one to pursue.” Josh James, founder and CEO of Omniture and Domo

Omniture, which Adobe purchased in 2009, was one of Inc. Magazine’s fastest growing companies of its era. After selling his groundbreaking digital marketing and web analytics company to a software giant (for $1.8 billion, no less), James went on to found Domo. He was driven to create the SaaS company by all the problems which had been keeping him up at night, during his stint as the CEO of Omniture.

Quote 3:

Your reputation is more important than your paycheck, and your integrity is worth more than your career. Ryan Freitas, co-founder of About.me

Founded by three men, Freitas, Tony Conrad, and Tim Young, about.me was purchased by AOL only four days after being publicly launched, in December 2010. Little over two years later, one of its initial founders, Conrad, bought it back, because he saw no advantages in About.me being owned by AOL. It was a matter of business ethics: where AOL wanted content, the startup’s founders wanted social networking. This move took them back to being a startup and going through another round of funding to get things going again.

The takeaway: What all of the above quotations and stories have in common is the spark of passion and genuine interest. Here are some of the most successful and richest people in business, all telling you the same thing: don’t invest in an industry just because it’s hot and profitable. Ask yourself if you can see yourself caring about it in five years’ time. If the answer is yes, then keep on going.

3. Address a need

Thus far, we’ve established that creating passive income online can be quite similar to entrepreneurship. That’s likely because of the democratic nature of the Internet: on the World Wide Web, people are used to getting value for free, so in order to bank on your audience, you’re going to have to come up with a great Unique Value Proposition.

The single sure-fire way to doing this is to identify a need shared by your audience, an opportunity on the market, in the sense that your potential customers are not having their needs met. Then, create a product (see list below) that fulfills that need in the most straightforward possible way and sell it for an acceptable price.

Here are 5 great passive income opportunities worth cashing in on online:

Before we begin, though, bear in mind that all these examples on how to accrue passive income online are only truly passive if you pay someone to do the work for you. In other words, you leverage someone’s assets through your capital, in one of the safest investment strategies currently available on the market.

  • SEO campaigns. Like most income streams on this list, they require time and work, and are best left to competent experts. However, once they start working, they work like a genuine digital cash cow. Here’s the logic behind this: by carefully optimizing the content on a website for low competition, high CPC long tail (read: highly specialized/niched) key phrases, you’ll attract all the right traffic. That’s when the website will start making money for you—anything in the $75 to $100/month category is a great place to start.
  • Information products. This entails anything that can be downloaded for a cost, be it stock photography, worksheets for librarians, video tutorials in any field on Udemy.com, stock music or sound effects, e-books in .pdf format, and so on. Be warned, though, that it takes time and effort to create a successful product: not only would you have to create it, but also market it, and sell it. Amazon does have a good platform for selling e-books, for instance, but it can take up to 6 months before you start capitalizing on your initial investment. To boot, it’s hard to find a field in which the content you produce stays evergreen… forever. Keeping it up-to-date will involve subsequent efforts.
  • Multi-tier affiliate marketing programs. You create a website, add content to it, then include a special link, with an embedded tracker, which tells a third-party seller you’re referring traffic to their products. For each click, you get somewhere in the range of 15 to 20%. Sounds like an easy money generator, right? In theory, it might. In reality, there can be no affiliation to speak of, if your website has no following, i.e. traffic. Attracting traffic is hard work, and so is keeping it. If the volume of visits to your affiliated website drops, you might find that Amazon has decided to put an end to your participation in the program, without too much prior notice.
  • Peer-to-Peer loans. There are several online platforms out there, which are considered and regarded as intermediaries between private lenders and private debtors. The lenders earn returns in interest, which can range from 8 to 12%. However, there’s no way of securing such loans, so you always risk losing all that investment money. A safe strategy to this passive income strategy is to have a very diverse ‘portfolio’, with more than 100 debtors to your name. Make sure you carefully examine the profile and historic data available on your debtor before committing to anything. Also, bear in mind that such a diverse portfolio requires a time investment to be maintained—you will need to keep reinvesting that money, if you want to accrue sizeable interest.
  • Sell your products through affiliates. Once your products are successful enough and you’ve accrued at least some online reputation to speak, you can start investing in affiliate links for your own products. How does this work? In a wide range of ways, but it all starts with a product that is good value, and that other bloggers/webmasters might benefit from promoting. This can be a downloadable digital product, or virtually anything up for sale online—it can even be a link to your online shop. Your goal when deploying this strategy is to accumulate backlinks and eventually convert them into sales. The clever aspect of such an investment is that you only have to pay rate-based commissions to your affiliates when your products start selling.

The takeaway: Whatever option you choose, you’ll be essentially generating income from passively selling something: advertising space on your website, a digital or tangible product, or money with interest. In all these scenarios, it’s important to identify your ideal customer, find them, speak to them genuinely, and convince them that what you’re selling online will help solve their problem.

4. There is no such thing as completely passive income

Example 1: You invest into real estate property, turn a rundown home around with your financial investment, and then rent it out to generate passive income. You might choose to hire a property manager or manage the property yourself: either way, you will still want to check in from time to time, to make sure everything is going according to plan, both for your tenants, as well as for your own investment.

Example 2: You decide to invest in the stock market. You consult with several experts, select your own broker to work with, then build your portfolio. No matter how trustworthy your broker, you’re still going to want them to consult with you before choosing what to buy or what to sell in your name.

Example 3: You invest in income-generating websites. You might write some ever-green content yourself, hire a freelancer to help you out, or completely outsource the content generation services to a digital marketing agency. Whatever you choose, managing that investment is going to require some periodic assessment of your websites’ results and evolution.

The takeaway: Completely passive income exists just about as much as unicorns do. Irrespective of the types of passive incomes you opt for, there’s always going to be a need for you to invest some time in the process. This will hold true even after you’ve put in the upfront investment. However, the major advantage of online passive income is that it relies on so-called ‘businesses of automation’, which will make your life as an investor far easier. In a nutshell, once all these automated processes are up and running, all you have to do is a bit of periodic maintenance work.

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