On 15th August, we celebrate Independence Day and the spirit of freedom. Along with celebrating freedom, this year, think about financial freedom. Financial freedom can give you control over your time, allow you to pursue your passion/hobbies, and spend without any worries. Let us understand how passive income can be your pathway to financial freedom.
What is passive income?
Passive income is a source of income that is generated automatically with little to no active effort. It is usually recurring in nature. Passive income may require a one-time investment and is usually self-sustaining.
For example, you invest a specified amount in a fixed deposit at a specified interest rate for 3 years. You opt for a monthly interest payout. In this case, you will keep getting a specified amount of interest every month for 3 years. This monthly interest amount is known as passive income. On maturity, you will get the principal amount back.
In the above fixed deposit example, the principal amount is invested once. The passive income, i.e. interest, is paid automatically to your savings account every month on a specified date. It doesn't require any effort on your part. As the interest is paid monthly, it is a recurring source of income.
When your passive income makes up a significant percentage of your overall income or exceeds your active income, it can give you financial freedom.
Sources of passive income
You can start building multiple sources of passive income over a period of time. Let us look at some of these passive incomes:
Interest income: You can get monthly interest income from fixed-income instruments such as fixed deposits, bonds, etc. These instruments can give interest income monthly, quarterly, half-yearly, yearly, or on maturity. If you are looking for monthly interest income, you will have to select that option in a fixed deposit application form. Regarding bonds, you will have to opt for those that pay monthly interest.
Dividends from equity shares: While many companies declare regular dividends, the frequency and the amount per share are not fixed. Companies may pay quarterly, half-yearly or yearly dividends. Some companies may pay occasional special dividends. The dividend per share depends on the company’s profit, current cash flows, accumulated cash reserves, etc. During a bad financial year, the company may skip the dividend. Ideally, you should look for growing companies that increase the dividend per share annually. Some companies, like TCS, HCL Tech, etc., pay quarterly dividends.
Rent from real estate: You can invest in residential or commercial property and give it on rent. Usually, the rent increases over a period of time. However, during times of economic downturn, the rent may go down. Earning rent as a passive income requires a huge investment in real estate; hence, it is not everyone's cup of tea.
Due to the huge investment involved, instead of buying the entire property on your own, you may consider the concept of fractional real estate. Some start-ups and other companies offer it. In this case, multiple people come together and own a property. Each individual owns a fractional share depending on the proportion of investment made. The rent is shared as per each individual's share.
If fractional real estate is also out of reach, you may consider buying shares/units of a listed real estate investment trust (REIT). The listed REITs in India include Embassy Office Parks REIT, Mindspace Business Parks REIT, Brookfield India Real Estate Trust REIT, etc. You can buy a REIT share for less than Rs. 400. REITs declare quarterly dividends, referred to as Distribution Per Unit (DPU).
Quarterly distributions from InvITs: Infrastructure Investment Trusts (InvITs) raise money from investors and invest them in infrastructure assets such as power transmission lines, roadways, mobile towers, etc. They declare quarterly DPUs. The listed InvITs in India include Indigrid InvIT, Powergrid InvIT, IRB InvIT, etc.
InvITs can provide you with passive income in the form of quarterly DPUs and also have the potential to offer capital appreciation in the long run. As the InvIT grows its revenue by investing in more infrastructure projects over a period of time, there is potential for an increase in DPU.
Monthly cash flows from alternative investments: In the last few years, many start-ups have emerged in the alternative investments space and are offering passive income opportunities. For example, Peer-To-Peer (P2P) lending platforms provide investors an opportunity to give loans to borrowers directly. The investors earn a monthly EMI, which includes the interest as a profit and passive income source.
Some start-up platforms provide asset leasing as an investment opportunity. In this, the start-up platform pools money from investors, buys assets and leases them to a corporation. These assets can include office furniture, vehicles, etc. The corporation makes a monthly payment to the investors, which may include a portion of the principal and return on investment.
Some start-ups offer invoice discounting as an investment opportunity. Investors pool money and give it to a corporation against an unpaid invoice. The invoice is discounted at a certain rate which is the profit for investors.
While all the above alternative investment opportunities have the potential to provide high returns as passive income, they come with high risks. Investors should assess their risk profile and accordingly decide whether to invest.
Other sources of passive income: Many other passive income sources can be considered. Some of these include starting a blog or becoming an influencer on social media platforms like Twitter, Facebook, Instagram, YouTube, etc. An individual can earn money from such platforms through advertisements, sponsorship, paid promotions, affiliate marketing, etc.
An individual can become an insurance advisor, mutual fund distributor, etc. and earn income by recommending need-based financial products. An individual can also earn passive income through royalty from book sales or selling online courses/ebooks, etc.
How can passive income give financial freedom?
You can start building multiple sources of passive income over a period of time. Initially, the passive income may form a small portion compared to your active income. But you can make a long-term action plan and grow your passive income over a period of time. Once your passive income exceeds your active income, you may take a call on whether you want to give up your active income source and live on your passive income.
You should always diversify your passive income sources. If one of them faces issues or fails, you can rely on the other sources. Passive income gives you control over your time. Once your passive income grows substantially, you have the option to quit your full-time job and free up your time. You can then decide to spend time with family, pursue your passion/hobby, travel, participate in a social activity, etc. With a good passive income, you can fulfil all your financial dreams and enjoy true financial freedom. While celebrating Independence Day this year, think about financial freedom and plan for achieving it.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.