Best passive income ideas

Most people will likely associate income with the salary they receive from a regular job. But there are other ways to earn some extra income that should involve a bit less time and effort. In this guide, we summarise the different types of passive income and how much you might be able to earn.

What is passive income?

Passive income is a form of income that doesn’t come from a “proper job”. Work you receive a salary for from an employer, or self-employment where you invoice clients for the work you do, for example. The idea behind passive income is that it doesn’t require huge amounts of ongoing effort to earn, though you may need to put in a bit of time, effort and money up front.

What are the different types of passive income?

There are a few ways in which you can earn a passive income, including:

• Saving and investing. A number of savings accounts and investments pay income in the form of interest or dividends.
• Selling or renting out assets you own. Your car, your property, your driveway, even designer clothing could earn you a few quid. There’s some overlap here with investing, as some investors include property as part of their investment portfolio.
• Ad revenue. This one’s a little niche as it requires you to have a blog or website, which in itself will require some effort. But, if you do, and it’s reasonably popular, then adding revenue-generating affiliate links or ads could generate a bit of income.

What’s the best way of making passive income?

The best way of making a passive income will depend on your personal circumstances. If you don’t own a car, you can’t very well earn money from renting it out, after all.

The way of making income that’s most likely to be an option for most people is saving and investing. To start making money from that you need to have some money to save or invest. But you don’t need to own any other assets or publish a website. So in the rest of this article, we’ll focus on earning a passive income through saving and investing.

What types of saving and investment let me earn a passive income?

Broadly speaking, there are two main reasons to save or invest your money.

1. To grow your money for a future goal
2. To draw an income.

The two don’t have to be mutually exclusive. Some options let you draw some income while your initial capital continues to grow. Here are the main options that you can potentially use for a passive income.

Interest from savings accounts

As of May 2023, the best easy-access savings accounts pay upwards of 3% interest on savings. Or, if you’re willing to lock your money away for a year (and delay receiving any income), you can earn around 4.5% with a 1-year fixed-rate bond.

We’re not going to lie though. Unless you have a lot of money to squirrel away, the level of passive income you’ll be able to earn from savings will be pretty low. Even at a rate of 4.5% (paid annually), putting £10,000 into savings would only earn you £450 a year. Enough for a weekend away, perhaps. This isn’t to be sniffed at, but only a tiny fraction of what most people need to live on. And there’s no chance of capital growth beyond the interest you earn. Plus with annual inflation at around 10% as of March 2023, money in even the best-paying savings account will be losing value in real terms.

This doesn’t mean it’s not worth having some money in savings. In fact, it’s recommended to keep enough to cover a few months’ worth of essential outgoings in an easy-access account to cover emergencies. But don’t give up your day job just yet.

Interest from government or corporate bonds

Investment bonds are effectively loans to government (also called gilts) or companies (corporate bonds). In exchange for these loans, investors receive an agreed rate of interest. Over the 30 years to the end of April 2023, the yield (annual interest) on government bonds has been just over 4%. The yield on corporate bonds can be higher than gilts. That’s because there is usually a greater risk of businesses defaulting on their loans than of the government doing so, particularly if the company is less well established. This means that companies have to pay a higher rate to balance out the higher risk.

But, while interest rates on bonds can be higher than those on savings accounts, you’d still have to invest quite a lot of money to earn a decent income.

Dividends from investments

Dividends are shares of the annual profits of companies that are paid to investors. Not all investments pay dividends, though. There are three main types of investment that may pay dividends.

• Dividend stocks. If you invest directly in stocks and shares, you may benefit from dividend payments as well as (hopefully) growth of the underlying investment. Usually (though not always) the better a company performs, the higher the dividend payments. If you plan to rely on dividends to form part of your income, the best option is usually stable, well-established companies with a proven track record of decent dividend payments. Smaller, newer companies may sometimes pay higher dividends. However, their performance is typically more volatile, meaning that future payments may not be as certain. And bear in mind that not all shares pay dividends. With some, money that might have been paid to shareholders is instead invested back into the company to generate growth. This (in theory at least) means you should end up with higher long-term returns as a trade-off for not receiving dividends.
• Income funds. Some, but not all, funds – such as dividend ETFs – pay dividends in addition to the capital growth that most funds aim for. This may apply particularly to funds that are made up largely of stocks (also known as equities). If you want to draw an income from the funds you invest in, look out for funds that specifically state they offer this. They may even have “income” or “dist” (distribution) in their name. If they have “growth” or “acc” (accumulation) in their name, they’re unlikely to pay dividends as their focus will be on reinvesting profits to maximise growth. Many investment platforms may offer filters that let you narrow down your fund search to only those that pay an income.
• Investment trusts. These work in a similar way to funds, in that by investing in an investment trust you’re investing in multiple assets at once. But, unlike funds, when you invest in a trust, you become a shareholder in the trust company. As a shareholder, you’ll generally be entitled to a percentage of the income generated by the trust’s investments. While this isn’t guaranteed, investment trusts can keep up to 15% of the annual income in a given year. This can then be used to smooth out income payments in years when the trust underperforms.

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Rental income from property

Many may argue that property is the best investment if you’re looking for an income. Income could be generated either through buying properties, doing them up, and selling them on at a profit, or by buying and renting them out.

However, both options are likely to require a substantial up-front investment plus ongoing costs (think mortgages and maintenance). Plus, potentially a fair bit of time and effort on your part if you choose to manage your property (or properties) yourself rather than employing a managing agent. In fact, investing in property for income arguably blurs the boundaries between passive income and a proper job.

What are the advantages of passive income?

This feels a bit like stating the obvious, but the key advantage of passive income is more money in your pocket for (relatively) little effort on your part. If you’re able to earn a decent amount from passive income, this may allow you to work less (or retire earlier), leading to a better work/life balance. Or if you’re happy with your working hours, it can simply provide a nice little boost to your lifestyle.

Bottom line

Passive income has the potential to provide a welcome supplement to your monthly finances at a time when prices seem to only be going in one direction. You’ll typically need a bit of up-front capital and be willing to put some effort into selecting and setting up the right options. But, after that, the idea behind passive income is that it should generate with relatively little ongoing input from you. If you’re saving or investing, just make sure that drawing an income is the best option for your situation. Reinvesting any interest or dividends could make your money grow faster and help you achieve your long-term goals that bit sooner.

Frequently asked questions

• Should I keep or reinvest my income from dividends?

  That depends what you are trying to achieve. If one of your main investment goals is to bolster your finances with income from your investments, then obviously it makes sense to keep the dividend payments. But if your main goal from investing is long-term growth, and you earn enough from other sources without the dividends, then – nice as they are – those dividends can probably work harder for you reinvested into your portfolio.

• What is the easiest source of passive income?

  Arguably the easiest source of passive income is to put your money into a savings account that pays decent interest. It requires very little effort to set up, the rate is likely to stay fairly stable (for at least the term of any initial deal) so you don’t need to pay regular, close attention to the account, and there’s no risk of capital loss. However, there’s also no chance of capital growth to complement the interest you withdraw. This means you are likely to lose money in real terms when you take inflation into account. So it may be worth considering alternatives that may involve a bit more effort on your part, but could net you better long-term returns.

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