Also known as: Passive income, Income from assets

Passive income

Income that requires no direct involvement once the money or work has been put in. Typically it is a return on assets: dividends, interest or rent.

Passive income is what arrives regularly without your having to put in hours for it again. Rent from a flat, a dividend from a share, interest from a bond.

The word "passive" is somewhat misleading, though. Almost always there was a very active phase first: either you set aside substantial capital, or you did work that goes on earning afterwards.

Where it actually comes from

Dividends: A share of a company's profit paid to shareholders. It is not guaranteed: a company can cut or cancel it at any time.

Interest: The reward for lending money, whether to a bank on a term deposit or to a bond issuer. More predictable than dividends, and usually lower.

Rent: Income from letting a property. The least passive of the three: it requires management, repairs and dealing with tenants.

Selling part of the portfolio: Formally this is not income but the sale of assets. In practice it is the most common way to live off a portfolio and if the value is growing, the assets can still be larger than at the start.

How much capital it takes

This is the question most discussions of passive income skirt around. The wealth required is worked backwards from the income you want:

K = \frac{I}{y}

$K$ : the capital required
$I$ : the annual income wanted
$y$ : the net rate of return

A worked example

You want a passive income of €500 a month, that is €6,000 a year.

Source	Real net return	Capital required
Term deposit	~2%	€300,000
Dividend portfolio	~3%	€200,000
Letting a flat	~4%	€150,000

Even on the most optimistic scenario you need a hundred and fifty thousand euro to receive five hundred a month. That is the reality marketing promises about passive income tend to leave out.

What to watch out for

Tax and levies. The returns above are gross. In Slovakia, income from dividends, interest and letting is taxed, and some of it also carries health insurance levies. Net income is noticeably lower.

Inflation. The same rent in nominal terms buys less in ten years. Genuinely sustainable passive income has to grow at least as fast as prices.

Rent is not passive. An empty month, a broken boiler or a tenant who does not pay turn "passive" income into a very active problem. Work out the real return only after deducting vacancy, repairs and your own time.

How long it takes to build the capital for the income you want is shown by the FIRE calculator together with the compound interest calculator.

Where it actually comes from

Dividends

A share of a company's profit paid to shareholders. It is not guaranteed: a company can cut or cancel it at any time.

Interest

The reward for lending money, whether to a bank on a term deposit or to a bond issuer. More predictable than dividends, and usually lower.

Rent

Income from letting a property. The least passive of the three: it requires management, repairs and dealing with tenants.

Selling part of the portfolio

Formally this is not income but the sale of assets. In practice it is the most common way to live off a portfolio and if the value is growing, the assets can still be larger than at the start.