7 Passive Income Sources that Lead to Wealth Creation

Being able to attain financial freedom takes planning and dedication. It is widely known and documented that the average millionaire has 7 sources of income. Below I will list out and provide details on common passive income sources that help contribute to being financially free.
Passive income sources include traditional investments such as stocks and bonds as well as alternative investments such as real estate and private equity among others. Each source has its own risk and reward profile as well as varying degrees of capital requirements. In this blog post, I will highlight the degree of ease in generating good returns from each source. The main idea of passive income is to have your money working for you even while you sleep. Some of these sources take some initial research and leg-work to get going while some do not take as much as others do.
Source 1: Dividends from Stocks 
The first and most common of the passive income sources is the quarterly dividends from the equity markets. You can purchase stocks on a stock exchange using a platform such as M1 Finance. Some stocks are classified as growth stocks and generally do not pay out dividends while some stocks are dividend aristocrats that have been paying dividends consistently over the years. It is not uncommon to see dividend yields in the range of 2-4% for such stocks. The tax treatment of a dividend stock depends on its classification. It could either be an ordinary dividend (taxed at your ordinary income tax rate) or a qualified dividend (taxed at typically a lower tax rate for most high income earners). Dividend stocks can also provide the upside of appreciation through growth if the share value increases past the cost basis.
Source 2: Interest from Fixed Income
Another popular instrument used to generate passive income is through fixed income. Typical examples are bonds and certificate of deposits (CDs). These are debt instruments with generally less volatility compared to the equity/stock market. The risk on a bond varies depending on what type of bond it is. Usually, junk bonds with lower credit ratings are risky when compared to government treasuries. I am a huge proponent of insured municipal bonds which are issued by states, cities, and counties since they are typically tax-free. You can typically realize a coupon rate of 2-5% on bonds while CDs can provide 2-3% annually in fixed income. CDs when compared to bonds are safer since you are guaranteed to recoup your principal if you wait till maturity. Depending on your age and risk profile, it is typically suggested to have some fixed income to balance out the volatility in the stock market. You can purchase bond ETFs on the M1 Finance platform.
Source 3: Real Estate Rental Income
Traditional real estate is one of the oldest forms of investment and it has been around for a while. Traditional real estate typically requires a high initial capital but it can be well worth it if the property is managed properly. Recent real estate vehicles such as eREIT (electronic real estate investment trusts) pioneered by Fundrise offers investors a new way to invest in the industry for a low minimum. You can read about my review of Fundrise. You can also purchase REIT stocks on the M1 Finance platform to get some exposure to the real estate market. REITs are required to pay out 90% of its taxable income to shareholders so the yield of REITs are typically much higher compared to regular dividend stocks. The yields from REITs can range from 3-12%.
Source 4: Peer-to-Peer Lending
Another source of passive income is peer-to-peer lending. This is simply the practice of lending money to an individual or business for a specific return on the principal loaned. Similar to most investment vehicles, peer-to-peer lending has a varying amount of risk-to-return profile. The more risky loans typically have a higher return but it is important to be mindful of the credit rating for each of these loans. Typical returns within this space can range from 3-8% on average and the length of the loan can vary from case to case.
Source 5: Private Equity
Private Equity as a passive income source provides an opportunity to invest in alternative investments that are not listed on a public exchange. Private Equity is notoriously known to be open to mostly accredited investors. An accredited investor by definition is an individual investor who has earned $200,000 annually within the last 2 years or someone with a net worth of at least $1 million. The typical return is around 8-20% and the initial capital requirement can be high. There are private equity firms such as Blackstone and KKR who help fund private companies as well as engage in buyouts of public companies. Private Equity is a high risk, high reward asset class and can be very rewarding when things work-out as planned.
Source 6: Royalties
Royalties can take on many forms. From owning oil and gas minerals to owning rights to a book. Royalties are payments made to the owners for the right to use that product. Owning minerals passed on through generations is a great source of income as it typically requires no capital to exploit that resource and the capital is supplied by the whoever pays to be the operator. It is important to be aware of intellectual property laws as they directly impact and govern the rules that enforce legal rights to tangible and intangible assets. Needless to say, royalties that be a great source of passive income.
Source 7: Capital Gains
This is the classic “buy low, sell high” asset class. Capitals gains usually occurs when there is a profit due to the sale of a property or an investment. The investment can take various forms including selling a share of a stock to selling a property. It is important to be aware of the impact of time on capital gains tax rate as long-term capital gains (usually a security held for at least a year) are usually taxed at a lower tax rate. The return on capital gains can vary widely as that depends on market conditions.
Final Verdict
Whatever passive income route you choose, it is important to be knowledgeable of that asset class. With time, you can start to realize the benefit of compounding. Albert Einstein once called compound interest the eight wonder of the world and there is a reason why. Once you master it, you can be on your way to financial freedom by having your money make money for you!

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