It’s one of those things you might hear about quite frequently, but what exactly is a passive income and why is it so great to have anyway?

What is Active Income?

We can introduce the concept of passive income by first understanding what active income is. Active income is the money that you earn by working either at a job or your business. The active income stream stops when you stop working; your employer will not pay you if you no longer work. On the other hand, passive income continues to get generated even though you are not actively participating in the process.

Passive income is automatically generated irrespective of whether you work or not, provided you have taken adequate initial steps to set it in motion. The word ‘passive’ does not refer to the amount of money generated, it refers to the fact that the recipient is not actively working to earn the money. The two biggest sources of passive income are rental activity (renting out residential or commercial space) and opting to become what is called a ‘sleeping partner’ in business. A sleeping partner invests his money but does not participate in the actual business process.

Understanding Passive Income

Passive income can help you increase your personal wealth and sour you on the road towards financial independence. If you wish to switch your job or develop other sources of passive income, this will not impact the passive income which is getting generated. Contrary to popular opinion, passive income does not refer to a one-time transaction.

For example, if you sell inherited property, this does not count as passive income on its own. However, if you invest that money into savings, deposits or treasury bonds or rent out the property, you can then activate a steady stream of income that is referred to as passive income. The concept of passive income implies a process that involves continuation over time.

Passive income does not imply that the income will last for a lifetime. As with any investment, interest rates may change with shifting market dynamics or the economy may experience a downward spiral.

Some activities will generate a completely passive income (for example, investing money in securities; the interest may go directly go into your bank account). Other activities may be semi-passive, for example, you may have to maintain the property that you have rented out in order to generate an income stream.

Whatever you decide, when taking steps to create them, bear in mind that it’s a good idea to develop multiple streams of passive income in order to minimise risk and maintain a steady stream of extra income.