For most of us, a major source of stress is a financial one. Covering your bills or doing the things you want to without worrying about how your bank statement would look like requires additional income. Gaining financial freedom is possible, if you set your mind to it. The most important part is to learn how to generate passive income. In other words, in order not to worry about your financial well-being, you need to earn extra income without working more for it.
It is about learning to make your money work for you, instead of working for your money.
In this post we will explain exactly what is meant by financial freedom, walk you through some concepts you need to grasp, and explain the different options for generating passive income. We focus on the mindset and concepts behind generating passive income here, while in our other post we share 11 Passive Income Ideas To Earn Extra Money.
Since you are here, you probably want to check out these posts too:
- Financial Independence Retire Early – 5 Step Guide
- Financial Freedom – 12 Steps For Beginners
- How To Be Frugal – 15 Money Saving Tricks
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Passive income defined
Passive income is any earnings that come from a source such as an asset for which you do not have to work for. Investopedia adds that it is income earned through enterprises where a person is not actively involved. It is money that you can earn while you sleep. While the word passive might indicate that you do not have to do anything at all for it, that isn’t entirely true. There is always some maintenance and management that needs to be done to keep the asset generating passive income.
There are very rare occasions in which you will earn passive income with doing absolutely nothing for it. We are not saying this to discourage you, passive income is still a much better way to earn your money than active income. We just want to make it clear that it doesn’t mean not working at all for your money, but rather maintaining an asset that generates money, which requires some work too.
The concept of assets and liabilities
When learning how to generate passive income, one of the most important things to know is the difference between and asset and a liability. Simply put, an asset is something that puts money on your bank account and a liability is something that takes money out of your bank account.
If you have ever had a course in accounting or finance, you will know that this is not the classic definition of assets and liabilities. Yet for the purpose of explaining the concept of how to generate passive income, it is important to adopt this definition.
Assets put money in your bank
An asset is anything in your possession that you can use to generate more money with. Assets include amongst others, cash on your bank account, rental real estate property, a business, products, and financial securities. All of these are things that if put in to use correctly, can generate you passive income. There is one more asset missing from the aforementioned list though.
Your time! Yes your time is probably your most important asset. And how you choose to spend it will determine how much income you can generate. You can use your time to earn money by working for it, or you could also create money generating assets. Investing your time into education will allow you to use your time more wisely as well.
Liabilities take money from your bank
A liability is anything that costs money to own or use. Think of your car, the home you live in, cloths, subscriptions to things like Netflix. We all have liabilities and we need them in order to survive and enjoy ourselves. Although liabilities take money out of your bank account, they are not necessary bad. However you should choose your liabilities carefully and make sure they maximise your satisfaction and happiness. We discuss this in details in our post with the 5 steps to financial freedom.
How do you really earn money while you sleep
There are several ways that you can generate passive income. We previously detailed 11 passive income ideas that you can apply. Nonetheless, our list is not an exclusive one, and you can always come up with new ideas.
Here we will explain the different options you have to earn passive income on a higher level to give you an idea the different directions you can go for. This might help you to spot new opportunities for generating passive income.
Assets that increase in value
One way to earn additional income is to invest in assets that increase in value over time. Basically you invest your money into an asset today with the expectation that it will go up ion value in the future. Once it has reached a certain point that you desire, you can sell the asset and enjoy the profits.
This option is possible with the majority of assets from stocks to real estate to business investments. Nonetheless, this option is quite risky since it is difficult to predict exactly what will happen to an asset in the future and how long it will take for an asset to increase in value.
Assets that generate income
The other option, is to invest into assets with the main purpose of generating passive income. These are assets that should be able to generate passive income from day one. These might be rental properties, dividend paying stocks, bonds, and other forms of loans.
All these assets have the main purpose of generating income in the short term. they may also go up or down in value, but the main aim of investing into these assets is to earn income passively.
The final options is to create products that can be sold indefinitely with little effort on your side. This might be a book, a music album, or photos. These are assets that you invest time and effort into while making them, and once you publish them they can sell forever.
Of course, if you want to increase your sales, you may need to invest money and effort into marketing the products. However if the products are of significant value for users, they might be sold by just placing them on the marketing place. It will not be the same level of sales as when you invest into selling more, however they will sell and earn you passive income.
Investing time or money
There are two main ways for acquiring assets that generate passive income. You can either spend time and effort creating assets from scratch or you can invest your money into them. Both options are good and have advantageous and disadvantageous. Let’s take a look at these two options.
Investing time to generate passive income
Investing time to create assets is suited for you if you do not have a significant amount of cash to work with. Through investing your time with the aim of creating passive income generating assets you can create products that will generate passive income. In our blog post with 11 passive income ideas we discuss 6 time invest passive income ideas.
The downside of this strategy is that it may take a long time to create those assets, and once they are created, there is no guarantee of how much passive income they will generate. You should do sufficient research ahead to make sure that the investment of your time and effort will indeed generate the expected passive income. Remember, your time is your most valuable asset.
Investing your money to generate passive income
Investing your money is more straight forward, and there are ways to calculate your possible return on investment, AKA your passive income. However, there are certain aspects to consider.
The more you can invest, the more you can expect in return. For instance a 5% return on $10,000 is $500 and 5% return on $100 is $5. As you can see the differences are quite significant. Furthermore, your returns also depend on your risk tolerance. The more risk you are willing to take, the higher the returns will be. If you are very risk averse, then your return on investment is likely to be relatively low.
Investing your money into the right assets also requires time and effort. You will need to do proper due diligence and research. This depends on your investment experience, and might decrease with time and more experience, however some time and effort to researching new assets will always be required.
Passive income not a get rich over night scheme
Creating passive income that you can live from takes time. It is not a get rich quick scheme, it is rather something that you build slowly over time. Of course the more you educate yourself and the more time and effort you put into acquiring passive income assets, the quicker you could live off of passive income. However in most cases it takes quite some time. You might make some mistakes along the way that will take you a few steps back. The important thing is to remain patient and know what your target is.
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