“Make money while you sleep.” “Have your money make money for you.” The slogans around passive income are tantalizing. But what’s the truth behind this concept? Can people really secure and rely on trustworthy passive income sources, or is this alluring idea more hype than reality?
There are a lot of get-rich-quick-schemes out there on social media to be wary of. If it sounds too good to be true, it probably is – and folks promising overnight millionaire status are usually up to no good. Passive income isn’t an effortless hack. But with time and diligence, people can build rock-solid income streams that will keep the money steadily rolling in long after they retire from their full-time jobs.
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What is passive income? Technically speaking, passive income is any sort of money coming in without active effort. In other words, money derived without having to perform labor for an employer on a recurring basis. There are many niche types of passive income which can be generated from things as diverse as mineral royalty streams, fractional ownerships in farms, peer-to-peer lending, rented-out parking spaces, music recording royalties and a multitude of other such off-the-beaten-path opportunities.
Here are five of the best passive income ideas for 2024 and 2025:
- ETFs and mutual funds.
- Dividend Aristocrats.
- Fixed income.
- MLPs and REITs.
- Real estate.
Passive Income Builder No. 1: ETFs and Mutual Funds
One leading passive income source involves broad equity portfolio products such as mutual funds and exchange-traded funds (ETFs), both of which own stocks and distribute their ensuing dividend streams to holders.
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To give one well-known example, the SPDR S&P 500 ETF Trust (ticker: SPY) is the largest ETF in America, and holds shares in the United States’ 500 largest companies. As of this writing, this ETF has nearly $600 billion in total assets under management. SPY offers a dividend yield of about 1.2%, implying that this singular ETF is set to pay out more than $7 billion in dividends over the next year to its shareholders. That sort of dough can help fund a lot of people’s retirements. And to reiterate, that is the total passive income pie distributed from just one of the more than 3,000 ETFs which are currently available in U.S. markets.
More broadly, there are funds covering specific sectors, countries, asset classes, thematic factors and more. Mutual funds, a closely related type of investment, offer similar far-reaching possibilities.
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Investors may complain about the relatively low yields offered by popular ETFs such as the S&P 500 ETF or the tech-heavy Invesco QQQ Trust ETF (QQQ), which tracks the Nasdaq-100. However, a great thing about the fund landscape is that investors can get products aimed at all sorts of more specific needs. There are funds focused on dividends, like the Schwab U.S. Dividend Equity ETF (SCHD), which offers a 3.5% dividend yield. This gives passive-income investors a bigger bang for their buck.
One can also consider going international, where equities tend to offer larger payouts. For instance, the Vanguard International High Dividend Yield Index Fund ETF (VYMI) has a juicy 4.3% dividend. Thanks to modern online brokerages, investors can quickly assemble a portfolio of compelling, passive-income-generating funds at low cost and minimum hassle.
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Passive Income Builder No. 2: Dividend Aristocrats
Dividend Aristocrats are defined as the S&P 500-listed stocks which have grown their respective dividend payments each and every year for at least the past quarter of a century.
There are currently 67 constituents of the S&P 500 Dividend Aristocrats Index. These 67 prestigious firms have been able to successfully increase their payout every year dating back to at least 1999. Many of them have been successful dating back to the 1980s, 1970s and, in some cases, even earlier.
Why does this matter? For passive-income investors, a key thing is that income keeps rolling in, rain or shine. People are counting on this income to fund retirements, family members’ educations, medical expenses and other non-negotiable needs. It’s of upmost importance that the income stream not be threatened. These select 67 companies have proven this with utmost confidence. They’ve been through the 9/11 attacks, the 2008 financial crisis, and the pandemic – navigating each catastrophe while keeping their shareholders safe.
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Merely maintaining a dividend through these crises isn’t sufficient to be a Dividend Aristocrat; these stocks must grow their payouts annually to qualify for the exclusive club. As the recent inflationary bout has demonstrated, the cost of living rises inexorably, sometimes at a frightening pace. Dividend Aristocrats give their owners the confidence that they will have the ever-increasing purchasing power necessary to keep up with inflation.
Passive Income Builder No. 3: Fixed Income
Fixed income is another proven choice for passive-income investors. This is a broad asset category which includes government bonds, corporate bonds, certificates of deposit and money market funds, among other options. Fixed income’s big appeal is that its asset prices tend to fluctuate much less than the stock market. While equities tend to rise over time, there can be unsettling volatility along the way. Fixed income helps investors sidestep that day-to-day uncertainty. Fixed income also has more protection for its owners than stocks. In recessionary times when businesses are failing, fixed-income instruments have much greater principal protection than many other asset classes.
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Over the past couple of decades, a recurring complaint with fixed income was that it simply didn’t offer high enough interest rates to fund the sort of lifestyles that passive-income investors tend to be looking for. But thanks to the Federal Reserve’s rate-hike campaign over the past few years, fixed-income investments can now deliver dramatically higher passive income streams than they did previously. This could change going forward, however, as the Federal Reserve recently began to reverse its prior interest rate increases. As a result, it could be a good time to lock in fixed-income investments now while interest rates are still quite attractive.
Passive Income Builder No. 4: MLPs & REITs
Alternatively structured yield-focused equities also help create passive income. Two classic examples are master limited partnerships (MLPs) and real estate investment trusts (REITs). MLPs allow investors to own fractional pieces of infrastructure assets such as pipelines, supply and logistic units, refinery services, and other such assets often tied to the energy industry. MLPs generally offer outsized dividend yields compared to the stock market as a whole. They also have unique tax treatment which can be beneficial to investors depending on their individual circumstances. In short, MLPs give investors access to ownership of unique, mission-critical infrastructure that would be too expensive or cumbersome to invest in otherwise.
Meanwhile, REITs give investors a tax-advantaged structure that prioritizes returning almost all of their profits to shareholders as dividends. REITs can own a vast range of different kinds of real estate including apartments, offices, storage facilities, shopping centers, and even more unique things such as data centers, cell phone towers and entertainment facilities. REITs give investors access to all these different real estate classes where it would be too expensive or impractical for investors to own the individual buildings outright.
By owning fractional ownership of hundreds or thousands of such buildings via a REIT, investors can set up a strong and diversified passive income stream backed by all types of real estate from around the country.
Passive Income Builder No. 5: Privately Owned Real Estate
Privately owned real estate is arguably the largest source of passive income in the world. This is where people own individual properties outright rather than fractional ownership via a REIT or other fund structures. The classic example would be owning an individual house or apartment unit and renting it out to tenants in order to collect monthly income.
Admittedly, there is some dispute over just how “passive” this sort of income is. Tenants have a way of calling and demanding that the landlord fix the toilet or replace the hot water tank in the middle of the night. Though this may be a less than 100% passive form of income, it’s hard to argue with the long-term returns. For people that have bought well-situated residential real estate and held it for decades while collecting juicy rents along the way, the results are often life-changing.
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The digital era has brought in additional possibilities within the passive income real estate space. Now landlords can rent out properties on short-term booking sites such as Airbnb Inc. (ABNB). These sites can potentially generate much larger amounts of passive income while also delivering more flexibility and control over the use of the property. These short-term rental sites require more active property management in terms of visitor check-in and check-out, property cleaning and so on. That said, for passive income devotees, much of this can be outsourced by hiring property managers and cleaning services to deal with the hassle.
