A Comprehensive Guide on Passive Income | Know It All!

calendarMarch 27, 2024
A Comprehensive Guide on Passive Income | Know It All!

In the times we live, achieving financial stability has become a challenge. Increasing inflation, market fluctuations, world events, and multiple investment and saving options, all often tend to confuse an individual. 


Beyond all these confusions, today we live in a time where everyone is becoming more and more aware of their finances and is continuously seeking different ways to increase their income. One such trending idea is - Passive income. 


In this guide, we are going to discuss everything about Passive Income, aiming to improve your knowledge of the subject while encouraging you to start generating passive income as it is one of the most effective ways towards financial freedom and stability. 


Here is the outline of what is ahead for you in this guide:


🔵 What is passive income?

🔵 Finding your financial independence number

🔵 Why should you consider generating passive income?

🔵 Is the concept of passive income too good to be true?

🔵 Do you need money to make passive income?

🔵 Key things you should know before beginning your journey to generate passive income

🔵 What are different sources of passive income?

🔵 Myths to beware of about passive income 




Let’s dive right in then. 

Chapter 1: What is Passive Income?

Passive income refers to money earned regularly with minimal effort or active involvement on the part of the earner. Unlike traditional forms of income, which typically require ongoing work or time investment to generate revenue, passive income streams continue to provide financial returns even when the individual is not actively working. 


The essence of passive income lies in creating assets or systems that generate revenue autonomously or with minimal ongoing effort. While building passive income initially requires time, money, or resources to establish, the ultimate goal is to create a stream of income that provides financial stability, flexibility, and potentially even wealth accumulation over time.


Passive income is often seen as a means to achieve financial freedom, allowing individuals to supplement their primary income, diversify their revenue streams, or eventually replace traditional employment altogether. However, it's important to note that generating passive income typically involves upfront investment, whether it be in the form of time, money, or expertise, and success often requires careful planning, strategic decision-making, and ongoing management of income-generating assets.


You might also like to read - Is passive income taxable?

Chapter 2: Finding your Financial Independence Number

Finding your financial independence number involves determining the amount of money you need to accumulate or the level of passive income you need to generate to cover your expenses and maintain your desired lifestyle without having to work actively for a paycheck. This can effectively mean a retirement corpus as well. 

Here's how you can go about finding your financial independence number or retirement corpus number:

  1. Calculate Your Current Expenses: Start by tracking your expenses over some time (such as a month or a year) to get an accurate picture of how much you're currently spending. Include all essential expenses such as housing, food, utilities, transportation, healthcare, insurance, and any debt payments. Also, factor in discretionary spending on items like entertainment, dining out, and vacations.


Let's say your current monthly expenses are as follows:


   - Rent: ₹20,000

   - Groceries: ₹8,000

   - Utilities (electricity, water, internet): ₹5,000

   - Transportation: ₹4,000

   - Healthcare: ₹3,000

   - Entertainment and dining out: ₹6,000

   - Total Monthly Expenses: ₹46,000


  1. Determine Your Desired Lifestyle: Consider the type of lifestyle you want to lead during financial independence. Will it be similar to your current lifestyle, or do you anticipate any significant changes? Be realistic about your needs and wants, as this will impact your financial requirements.


  1. Estimate Future Expenses: Anticipate any changes in your expenses that may occur during financial independence. For example, you may no longer have commuting costs if you're not working, but you might have additional healthcare expenses as you age. Adjust your current expenses accordingly to reflect your future financial needs.


Assuming a modest inflation rate of 5% annually, your future monthly expenses in, let's say, 20 years would be:


Monthly Expenses after 20 years = ₹46,000  (1 + 0.05)^20 ≈ ₹1,41,128


  1. Factor in Inflation: Account for inflation when estimating your future expenses. Prices rise over time, so the amount of money you need for financial independence will likely increase as well. Use a conservative estimate for inflation, typically around 4-7% per year.


  1. Calculate Your Financial Independence Number: Once you have a clear understanding of your future expenses, multiply this annual expense figure by the number of years you expect to be financially independent. This will give you a rough estimate of the total amount of money you need to have saved or invested to sustain your lifestyle indefinitely.


Let's say you plan to be financially independent for 30 years.


Multiply your annual expenses by the number of years:


Financial Independence Number = ₹16,93,536  x 30 ≈ ₹5,08,06,080

  1. Consider Withdrawal Rates: If you plan to rely on investment income to cover your expenses, you'll need to factor in a safe withdrawal rate. A commonly used rule of thumb is the 4% rule, which suggests that you can withdraw 4% of your investment portfolio each year without running out of money in retirement. Adjust this rate based on your risk tolerance and other factors.


If you plan to follow the 4% withdrawal rule, you would need a portfolio worth at least 25 times your annual expenses:


Portfolio Required = ₹16,93,536  25 ≈ ₹4,23,38,400


  1. Account for Additional Income Sources: If you anticipate receiving any other sources of income during financial independence, such as rental income, pension payments, or royalties, subtract these amounts from your total expense figure to determine how much you'll need from your investments.


  1. Review and Adjust: Your financial independence number isn't set in stone and may need to be adjusted over time. Regularly review your expenses, investment performance, and other factors that may impact your financial situation, and make adjustments as necessary.


By following these steps, you can calculate your financially independent number and create a plan to work towards achieving it. Keep in mind that finding your financially independent number is a personal process that depends on your circumstances, goals, and preferences. It's important to revisit and adjust your plan to stay on track toward financial independence.

Chapter 3: Why should you consider generating passive income?

There are several reasons why everyone must consider generating passive income. Below, we have listed all these reasons - 


⦿ Diversification & risk management

⦿ Financial Freedom 

⦿ A hedge against inflation

⦿ More time for what matters

To know more about each one of these reasons, you must check our blog importance of passive income

Chapter 4: Is the concept of passive income too good to be true?

Passive income is often depicted as a means to earn money effortlessly, even while you sleep. However, this portrayal doesn't always align with reality. 


According to Forbes, most passive income ideas demand an initial investment of time, money, or resources. Moreover, they necessitate ongoing monitoring or maintenance to ensure their effectiveness. Yet, unlike traditional employment, these pursuits typically don't demand extensive time commitments or obligatory social interactions.


The level of involvement required for generating passive income can vary significantly depending on the chosen methods. For instance, establishing a high-yield savings account or a certificate of deposit (CD) entails minimal initial research and a brief commitment to account setup. 


Conversely, real estate investment often proves far from passive. As noted by Kiplinger, the responsibilities of a landlord demand substantial time and effort, even when anticipated in advance. These obligations can range from handling costly repairs to managing evictions. While outsourcing such tasks is an option, it inevitably cuts into potential profits.

Chapter 5: Do you need money to make passive income?

When it comes to generating passive income, you will need what Investopedia refers to as “startup capital”. If you wish to create a passive income stream from financial assets like cash equivalents, stocks, and bonds, you will require a decent account balance.


Not all but some passive income streams need some sort of initial investment that doesn’t always have to be monetary like talent and time. For example, if you wish to sell an online course, you will not need a huge amount to invest but will need time and skill. 


Chapter 6: Key things you should know before beginning your journey to generate passive income

Before embarking on your journey to generate passive income, there are several key things you should know:


  • Understand the Concept
  • Set Clear Goals
  • Assess Your Skills and Resources
  • Research Passive Income Opportunities
  • Start Small and Scale Up
  • Be Realistic About Time and Effort
  • Stay Educated and Adapt


By understanding these key principles and factors before beginning your journey to generate passive income, you'll be better equipped to make informed decisions, set realistic expectations, and maximize your chances of success.


Explore each one of these points here in our article Things to consider before embarking on the journey of generating passive income

Chapter 7: What are different sources of passive income?

Irrespective of why you wish to generate supplementary income, diversify revenue streams, or optimize financial resources, generating passive income can be a huge help. Below, we have a list of passive income sources. 


  1. Fixed Deposits: Fixed deposits offer stable returns with minimal risk, but may not keep pace with inflation, particularly for long-term investors.


  1. Rental Income: Real estate investment yields steady rental income and potential asset appreciation, yet returns can fluctuate with market cycles and may not always surpass loan costs.


  1. Post Office Schemes: Government-backed post office schemes provide predictable interest rates, offering a secure and low-maintenance option for passive income seekers.


  1. Unorganized Money Lending: While offering lucrative returns, unorganized money lending entails risks such as difficulty in loan recovery and lack of legal recourse for defaults, requiring ongoing time and effort for management.


  1. Online or Offline Business: Starting a side business can be lucrative but demands entrepreneurial skills and managerial expertise, making it less suitable as a passive income source for everyone.


  1. Alternative Debt Investments: Investments in bonds of different types, corporate FDs, Regulated Peer-to-Peer Lending can generate predictable, low risk, consistent returns.


To know more about each one of these sources, you can check our blog Do you know which is the best source of passive income?

Chapter 7: Myths about passive income?

While passive income can yield significant returns over time, it's not a shortcut to instant wealth and requires patience and consistency. Accessing profitable opportunities doesn't necessitate substantial wealth, as there are options available for individuals of all financial backgrounds. 


Moreover, beginner-friendly passive income opportunities exist, and passive income isn't synonymous with alternative income sources, which encompass both active and passive income streams. 


Additionally, passive income ventures carry inherent risks, requiring diversification and risk management strategies. 


Bottom line: While passive income offers potential financial freedom, building sustainable streams mandates dedication, patience, and ongoing effort, emphasizing the importance of dispelling misconceptions and adopting sound strategies for financial prosperity. Learn more about common misconceptions about passive income in our article: Breaking Some Common Misconceptions About Passive Income (A Must Read For Beginners)