A couple of days ago, in How Lazy Bastards Make Money Without Lifting a Finger, we discussed the benefits of passive income.
Today we’ll dive into the nitty-gritty details on how to passively beef up your earnings.
Simply put, interest is the cost of cash. It’s money earned for money loaned.
Individuals, businesses, and governments pay rent for other people’s money.
Let’s say I lend you $1,000 at an annual rate of 8% on January 1st, 2013, with principal and interest due in one year. At year-end, assuming you don’t screw me, I’ll receive principal of $1,000 and interest of $80 for a total of $1,080.
Besides fork over $1,000 at the beginning of the year, I do nothing more than wait for the dough to roll in.
Nowadays, the interest paid on savings accounts, money market accounts, and certificates of deposit is so pitiful I won’t waste your time delving into the specifics of these vehicles. Just know you can buy them from mega banks, community banks, and credit unions.
Unfortunately, U.S. treasuries currently earn an interest rate that’s equally pitiful to the amounts paid by financial institutions.
There aren’t many opportunities to make legitimate, tax-free money these days.
Invest in municipal bond funds through a discount broker such as Charles Schwab or Scottrade. Municipal bonds are issued by state and local governmental agencies. Muni bond interest is spared from federal and often state income taxes.
There are two main ways to make money from ownership in a company: capital gains and dividends.
We’ll discuss how capital gains work in a later section. For now, let’s focus on how dividends let you squirrel away cash while watching back-to-back Seinfeld reruns.
In a nutshell, dividends represent the portion of a company’s profits paid to its investors. Non-employee shareholders receive a chunk of corporate earnings, and the company’s employees do the hard work of . . . well . . . working.
Big Brother bestows a special, maximum tax rate of 15% on what the IRS refers to as qualified dividends. Compare that with a federal income tax rate of up to 35% on income earned from a day job. Crikey!
Dividend paying investments include, but are not limited to, the following:
- Individual stocks
- Stock mutual funds, index funds, and exchange traded funds
- Real Estate Investment Trusts (Generally, ordinary federal income tax rates of up to 35% apply to dividends paid by a REIT.)
- Privately owned corporations
You can purchase most of the investments listed above through brokerage firms as well as financial institutions like Vanguard, Fidelity, and T. Rowe Price.
But unless you got a lot of dough laying around, you’ll likely have a hard time buying into a privately owned company. UK residents can invest small dollar amounts in startups through Seedrs.
Although U.S. company’s such as KickStarter and Indiegogo provide a channel for the little guy to fund private (and potentially profitable) projects, rewards are limited to the non-monetary warm and fuzzies you get from altruism. Who gives a crap about that?
Many of us are familiar with residential or commercial real estate that you lease out in its entirety. You have to get creative if you want to avoid the perils of traditional landlording.
The good news is you don’t need extensive amounts of capital or credit to earn passive rental income.
Use your primary residence to generate extra cash:
- Get a roommate or host travelers - Airbnb, Roomorama
- Loan your garage or spare bedroom to a small business for inventory storage - Craigslist
- Park on the street and rent your carport to commuters or patrons of nearby establishments - ParkCirca, ParkatMyHouse
One enterprising D.C. homeowner converted the first floor of his townhouse into coworking space. For $400 per month, entrepreneurs lease a desk, chair, high speed internet, and the use of other amenities found in a standard office.
Capital gains, generally, occur upon the sell of an asset you acquired–whether for personal use or investment purposes–at an amount greater than the purchase price.
For example, let’s say you unload a couple of Jodeci CDs on Craigslist for $15. You picked them up for $5 at a record store’s liquidation sale a few weeks earlier. The resulting capital gain amounts to ten bucks.
The Internal Revenue Code classifies capital gains as either short-term or long-term. If you own an asset for more than a year before you sell it, the excess amount you receive over what you paid is your long-term capital gain. Own the asset for a year or less, and you have a short-term capital gain.
As you might’ve guessed, the tax rates applied to short-term and long-term capital gains differ. Long-term gains receive a favorable federal income tax rate of up to 15%. Short-term gains are taxed at ordinary income rates, which, as stated previously, can climb up to 35%.
Personal property, real estate, or any asset listed under the Dividend Income section above can be sold for a capital gain.
WARNING: These investments are NOT risk-free. The possibility exists that you’ll lose money.
Search yourself to determine if you can stomach the risk.
Additionally, the Internal Revenue Code is a complex, convoluted mess of loopholes, penalties, and special treatments so do your own research to determine how taxes impact your personal finances.