How to earn a second income
Definition: what is passive income?
Passive income, also known as residual income, is a source of income that generates income over a longer period of time and develops positively and independently of the money or time invested.
What are the pros and cons of passive income?
Who doesn't dream of lying on the beach, letting the sun shine on their stomach and miraculously making money in the process? To be paid for doing nothing? As graphic as the idea of passive income is often, it should not be overlooked that it also harbors risks and is labor-intensive.
These are the benefits of passive income
- Independence: With passive earning, you are independent of working hours and place of work. So, for example, as in the example above, you can actually earn income while on vacation.
- Freedom: The increase in income gives you freedom that you can use, for example, to spend more time with your family or friends or to pursue hobbies.
- Security: Those who build up passive income as an additional financial pillar are financially more secure. With a passive income, you enjoy greater security, especially when it comes to building up your assets for retirement provision.
Those are the disadvantages of passive income
- Risk of loss: As with any investment, there is a risk of loss when it comes to passive income. In general, the higher the prospect of returns, the higher the risk.
- low predictability: Passive income can usually not be planned. Except in the case of very low-risk (but therefore also low-return) investments in time deposits, an exact profit cannot be predicted. Passive income can therefore usually only complement active income, not replace it.
- Investment of money and time: Nothing comes from nothing, and it is the same with passive income. An initial investment of money and time is essential to generating passive income gains. You must first have this start-up capital and this time, take this into account when planning.
You have these 3 options to generate passive income
There are different ways to generate passive income. The options for passive money-making can be roughly summarized in
- Interest and dividends
- as well as real estate
organize. In the following we present the advantages and disadvantages of the various options.
Earn passively money with interest and dividends
Interest and dividends from investments offer a good and, compared to the other options, low-risk entry into the subject of passive income. In the following, we will introduce you to the four most common forms of investment, ETFs, stocks, fixed-term deposits and daily allowances, and explain the advantages and disadvantages of these.
1st option: Use ETFs and stocks as passive income
Anyone who chooses ETFs and stocks to build up passive income has good prospects for returns. The principle is easy to explain: you invest in a company or in index funds (these are investment funds that replicate a stock market index) and receive dividends in return, which you can post as passive income - after all, you receive the money regardless of your labor input.
- good returns
- Risk diversification
- flexible and transparent
- Losses possible
- sometimes high custody and order fees
2nd option: Fixed-term deposits are only worthwhile as passive income for long terms
Fixed-term deposits are only partially suitable for building up passive income. You have to transfer a minimum amount (varies depending on the provider) to your fixed-term deposit account and create it for a previously agreed term. During this period, the money pays fixed interest. This offers you good planning security. The disadvantage, however, is that you cannot access the money flexibly if you need it spontaneously. In general, the longer you invest the money, the higher the interest.
- high security
- fixed rate
- comparatively low interest
- no flexibility
- larger investment amount necessary
3rd possibility: With overnight money it is currently hardly possible to generate passive income
Call money is a particularly straightforward investment. You open a call money account at the bank of your choice, transfer an individual amount to your call money account, which bears interest on a daily basis. You can withdraw your money at any time, but the bank can also change the interest rate at any time.
Anyone who chooses a call money account with a German bank is particularly well protected and European banks also offer very good deposit protection. However, the return on overnight money is currently extremely tight, more than 0.7% is currently not exceeded by any provider (as of 03/2019).
- high security
- high flexibility
Disadvantage:Overnight money comparison
Lending money as passive income
Those who lend money can earn money with it. This principle has also proven itself in the digital era. In addition, online platforms now make it very easy for users to lend or invest money.
4th option: Peer-to-peer credit: lending money from private to private
With peer-to-peer loans, you become a bank yourself through online intermediaries: you lend your capital to other people who pay you interest in return. The peer-to-peer business has become so sophisticated that, similar to building a portfolio of stocks, you can spread your risk, keep the amounts invested small and choose the projects you want to invest in yourself. The prospects for returns are good, depending on the project and the willingness to take risks, but with this form of investment you must never forget that a complete loss of the money you have invested is possible.
- even small amounts are possible as investments
- high return
- Risk diversification
- high flexibility
- Partial or complete loss possible
5th option: Invest in real estate, start-ups or energy projects with crowd investing
With crowdinvesting, private investors invest in real estate, in projects from the energy sector or in startups. In return for the money you invest, you will receive a respectable return. However, the risk involved in this form of investment should not be underestimated.
- high return potential
- Investing in innovative projects and products
- Risk of total loss
- early termination is not possible
- no influence on business decisions
Use real estate as a return object for passive income
Real assets such as real estate are largely independent of price developments and interest rates. Anyone who invests in so-called concrete gold can look forward to a good passive income through steady rental income.
6th possibility: passive income through real estate
Particularly in the current phase of low interest rates, when building money is cheap, investing in real estate is associated with good prospects for returns. Please note, however, that the financial and time investment is particularly high with this form of passive income. Administration and maintenance costs reduce profits and should be calculated with foresight. Anyone who buys apartments or houses with the intention of reselling them at a profit after a short period of time also has to invest work in the investment properties.
- high security
- long-term increasing yields
- high administration and maintenance costs
- Be careful with long-term financed real estate, you can expect rising interest rates for follow-up financing
4 tips on how to build up sustainable passive income
Earning money passively is no accident. In the following, we give you four tips that will help you build passive income streams and benefit from them in the long term.
1st tip: invest for the long term
Anyone who thinks that passive income is money quickly earned is very wrong. It takes long and strategic work until a significant income is built up through passive money flows. You should be aware of this, because it also means that you should under no circumstances rely on passive income in a financial emergency. Rather, you can see it as a time-consuming hobby alongside an active income that will pay off for you in the long term.
Tip 2: First, pay off your consumer debt
Do you have current installment loans? Then you should refrain from building passive income and dedicate yourself to the quick repayment of your consumer loans first. Credit debt is almost always more expensive than profits from interest income, rental income, or dividends, so creating passive income remains a negative business as long as you are in debt. The situation is different with ongoing construction financing: The repayment is usually planned for a long time and even if you have come to an early windfall, an early repayment often makes no sense due to the prepayment penalty that is due.
Tip 3: Develop your own investment strategy
Before you decide on a form of passive income, you should develop an individual investment strategy. To do this, you should ask yourself:
- What do you want to save or invest in? What is the goal of your passive income?
- How much money can you invest (monthly) without negatively affecting your running costs?
- How much time can you invest in building a passive income?
- Which investment horizon do you want to choose? When would you like to be able to fall back on the money invested?
- How would you like to invest: Are you more security-conscious or willing to take risks?
- How much loss could you get through without getting into financial trouble?
With the answers to this question, you can create an investment strategy that you should stick to for the long term. Frequent strategy changes are not advisable as passive income develops over a long period of time and requires some perseverance.
4. Tip: Check your investment strategy regularly
Take the time to reflect on your strategy. The best way to do this is to use a finance app or an Excel spreadsheet in which you enter your profits and losses on a weekly basis. In this way, you can gradually see which form of investment works for you and which less. In the end, passive income is not free money, but requires perseverance in addition to the investment of time and money.
Building passive income works best when you are passionate about it and observe carefully which systems work and which ones don't. Above all, it is important that you pursue a long-term strategy and do not allow yourself to be discouraged by small setbacks.
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