Passive income is money you make with minimal time and effort - it’s when your money or your assets effectively work on your behalf to boost your income.
Broadly speaking, passive income comes in three guises:
returns on investments
selling or renting out assets such as your car or property, and
asset building, which includes things such as selling services online, or adding revenue-generating affiliate links to your blog or website.
Here are some of the best ways to earn passive income in 2023.
Remember that investing puts your capital at risk - you may lose some or all of your money.
If you have money to invest in shares, the companies whose shares you buy may pay dividends to shareholders. Dividends are essentially a reward to shareholders paid out of company profits.
Companies are not obliged to pay dividends, nor is the level of payment guaranteed.
But dividends can provide a good passive income stream if you have the right shares in your portfolio, typically, ‘old economy’ stocks (such as energy, companies, utilities and banks) with large customer bases and an established business model.
The amount you receive is known at the dividend yield, which is calculated by dividing the company’s share price by the annual dividend. For example, if a company is paying annual dividends of £5 and has a share price of £100, the dividend yield is 5%.
As well as company shares, you might also receive dividends from investment trusts and funds.
Companies that pay dividends typically pay out in cash, once or twice a year. Special, one-off dividends are sometimes paid when, for example, a business is sold.
In 2021, more than one trillion pounds was paid out in dividends globally - a record high that looks set to at least be matched from the payments made in 2022.
It’s worth remembering, however, that not all companies pay dividends. For example, Meta (Facebook’s parent), Tesla and Amazon haven’t paid out dividends. Instead, companies such as these tend to reinvest the profits they make back into their businesses enabling them to grow.
Traditional ‘blue chip’ companies such as GSK or BAE Systems, on the other hand, tend to pay out higher dividends. Investment platform AJ Bell has predicted that total dividends from companies making up the FTSE 100 stock index would amount to more than £80 billion in 2022.
Take care with companies with high dividend yields, however, as figures can be artificially inflated by sharp falls in share prices.
Investment trusts invest your money in assets such as shares, and most pay dividends to investors. Investment trusts have a trading price that can go up and down according to demand.
Data from the Association of Investment Companies shows that seven investment trusts have increased their dividend payments each year for the last 50 years.
It’s important to look at a trust’s dividend yield when you’re deciding where to put your money, but you should also consider other factors, such as the trust’s prospects for growth.
Like investment trusts, funds contain an assortment of shares and other assets. Unlike trusts, however, they do not have a ‘live’ price that changes according to demand.
Instead, funds are re-priced once a day based on the values of the assets they contain.
Many funds pay dividends in addition to capital growth. Those funds whose primary focus is to pay an income can be found in the UK and Global Equity Income categories.
Most UK Equity Income funds pay a dividend yield of between 3% to 5%, according to investment information provider Trustnet.
Savings accounts and bonds
Interest on your savings is a form of passive income. Easy access savings accounts are currently paying rates nudging 2%, while savers can expect more from regular savings accounts - around 3.5%.
The returns are lower than you might receive from investing in stocks, shares and other assets, but the risk is also lower. Most savings accounts are protected by the Financial Services Compensation Scheme, which safeguards up to £85,000 of customers’ money (per financial institution) if a bank or building society goes bust.
Fixed-rate bonds can offer competitive rates of interest if you’re willing to give up access to your money for extended periods of time. Some accounts will pay 3.5% when you lock in for at least two years.
Premium Bonds are another alternative. Rather than paying interest, they give bond holders the chance to win tax-free, cash prizes of between £25 and £1 million each month.
There’s a 34,500 to one odds of winning a prize per £1 bond, equivalent to a 1.4% interest rate, according to National Savings & Investments (NS&I), which issues the bonds.
However, with inflation currently at a 40-year high of around 10.7%, any savings account paying out less than that in interest is effectively losing money.
Income from property
Though it involves the biggest financial outlay and commitment, investing in property can generate some of the most significant passive income.
It can be hard work and expensive, given the required maintenance and management of the property, however.
Property yields are the best measure of income from a property. Yields are calculated by dividing annual rental income by the property’s purchase price.
Property developers SevernCapital says property yields in 2021 ranged from 2.9% in London to 4.4% in the north west. NatWest, a buy-to-let lender, says a reasonable property yield is between 6% and 8%.
When you factor in fees or costs for property maintenance and management, a property yield can be lower still. However, with property prices tending to trend upwards over time, there may be benefits to investing in property over the longer term.