Most people will likely associate income with the salary they receive from a regular job. But there are other ways to earn some extra income that should involve a bit less time and effort. In this guide, we summarise the different types of passive income and how much you might be able to earn.
Passive income is a form of income that doesn’t come from a “proper job”. Work you receive a salary for from an employer, or self-employment where you invoice clients for the work you do, for example. The idea behind passive income is that it doesn’t require huge amounts of ongoing effort to earn, though you may need to put in a bit of time, effort and money up front.
There are a few ways in which you can earn a passive income, including:
The best way of making a passive income will depend on your personal circumstances. If you don’t own a car, you can’t very well earn money from renting it out, after all.
The way of making income that’s most likely to be an option for most people is saving and investing. To start making money from that you need to have some money to save or invest. But you don’t need to own any other assets or publish a website. So in the rest of this article, we’ll focus on earning a passive income through saving and investing.
Broadly speaking, there are two main reasons to save or invest your money.
The two don’t have to be mutually exclusive. Some options let you draw some income while your initial capital continues to grow. Here are the main options that you can potentially use for a passive income.
As of September 2023, the best easy-access savings accounts pay upwards of 4% interest on savings. If you’re willing to lock your money away for a year or more (and delay receiving any income), you could earn closer to 5% with a fixed-rate bond.
We’re not going to lie though. Unless you have a lot of money to squirrel away, the level of passive income you’ll be able to earn from savings will be pretty low. Even at a rate of 4.5% (paid annually), putting £10,000 into savings would only earn you £450 a year. Enough for a weekend away, perhaps. This isn’t to be sniffed at, but only a tiny fraction of what most people need to live on. And there’s no chance of capital growth beyond the interest you earn. Plus with annual inflation at around 10% as of March 2023, money in even the best-paying savings account will be losing value in real terms.
This doesn’t mean it’s not worth having some money in savings. In fact, it’s recommended to keep enough to cover a few months’ worth of essential outgoings in an easy-access account to cover emergencies. But don’t give up your day job just yet.
Investment bonds are effectively loans to government (also called gilts) or companies (corporate bonds). In exchange for these loans, investors receive an agreed rate of interest. Over the 30 years to the end of April 2023, the yield (annual interest) on government bonds has been just over 4%. The yield on corporate bonds can be higher than gilts. That’s because there is usually a greater risk of businesses defaulting on their loans than of the government doing so, particularly if the company is less well established. This means that companies have to pay a higher rate to balance out the higher risk.
But, while interest rates on bonds can be higher than those on savings accounts, you’d still have to invest quite a lot of money to earn a decent income.
Dividends are shares of the annual profits of companies that are paid to investors. Not all investments pay dividends, though. There are three main types of investment that may pay dividends.
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Read the full methodologyAll investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
Many may argue that property is the best investment if you’re looking for an income. Income could be generated either through buying properties, doing them up, and selling them on at a profit, or by buying and renting them out.
However, both options are likely to require a substantial up-front investment plus ongoing costs (think mortgages and maintenance). Plus, potentially a fair bit of time and effort on your part if you choose to manage your property (or properties) yourself rather than employing a managing agent. In fact, investing in property for income arguably blurs the boundaries between passive income and a proper job.
That depends on how much money you invest into passive income sources, and the rate of return. This can vary by the specific account or investment. Interest on easy-access savings, for example, can range from less than 0.5% to more than 3%. But to give you an idea, here’s how much you could earn each year on an investment of £20,000 in several types of account.
| Source of passive income | Rate of return (interest or yield) | Annual income from a £20,000 investment | Details |
|---|---|---|---|
| Easy-access savings | 3.71% | £742 | Best easy-access savings rate available on full £20,000 as of 2 May 2023 |
| UK government bonds | 3.78% | £756 | Based on 10-year gilt yield as of 2 May 2023 |
| Shares | 3.69% | £738 | Average dividend yield of the 100 stocks in the FTSE 100 stock index in 2022 |
Investing £20,000 into property wouldn’t get you much more than a shed in much of the UK, so we haven’t included it in our table. To give you a sense of likely returns, the average rental yield as of early 2023 is around 4.75%. This is calculated by dividing the annual rental income amount by the property value, then multiplying by 100. Rental yields can vary dramatically in different parts of the country.
This feels a bit like stating the obvious, but the key advantage of passive income is more money in your pocket for (relatively) little effort on your part. If you’re able to earn a decent amount from passive income, this may allow you to work less (or retire earlier), leading to a better work/life balance. Or if you’re happy with your working hours, it can simply provide a nice little boost to your lifestyle.
The main downside to drawing an income from your investments is that you will miss out on the effect of compounding. Compounding is where, if you re-invest the interest or dividend payments you earn rather than withdrawing them, you then earn further returns on the reinvested amount. Over the long term, the effect of compounding can really add up. It can result in your investments growing by hundreds (or even thousands) of pounds more.
If, of course, you invest specifically for the purposes of drawing an income, then this may not be a big issue for you. But if you’re investing in the hope that growth will help you meet your long-term goals, and don’t really need the income, then re-investing your interest and dividends could work out better for you over time.
Passive income has the potential to provide a welcome supplement to your monthly finances at a time when prices seem to only be going in one direction. You’ll typically need a bit of up-front capital and be willing to put some effort into selecting and setting up the right options. But, after that, the idea behind passive income is that it should generate with relatively little ongoing input from you. If you’re saving or investing, just make sure that drawing an income is the best option for your situation. Reinvesting any interest or dividends could make your money grow faster and help you achieve your long-term goals that bit sooner.
| Response | Female | Male |
|---|---|---|
| I would not choose a share trading platform | 30.57% | 26.09% |
| Fees | 20.63% | 29.35% |
| Don't know | 27.86% | 16.85% |
| Customer service | 15.96% | 22.01% |
| Provider reputation | 12.8% | 20.38% |
| Investment types covered | 13.25% | 18.21% |
| Number of investments | 11.75% | 17.39% |
| Whether it offers an ISA | 12.5% | 15.49% |
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
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