Passive income: making money while you sleep.
Sounds great, right?
This is the entire idea behind “retirement.” I use quotations, because most people nowadays agree that retirement simply means not having to work — it doesn’t mean doing absolutely nothing (how retirement used to be viewed).
How does passive income happen? Well, ironically, it takes a lot of work. Passive income doesn’t mean you never work, or you never worked; it means you don’t have to work currently to keep producing an income.
This is one of the most important finance concepts we could ever teach our kids, because it’s the primary path to full financial freedom. The freedom that will allow them to do anything…
How Passive Income Works
Passive income comes in many forms, but most often the forms are real estate, businesses, and dividends. You’ve also got royalties, peer-to-peer lending and unconventional investments, but they’re not as common.
Let’s quickly talk about each…
- Real Estate – This is the primary way people get passive income. You buy a house, which may cost a lot of money upfront. Then you renovate, or at least repair, some of the house. Once all of that is done, you can now rent it out, and earn passive rental income each month.
- Businesses – Owning a business is risky, but it can be highly profitable. 20% of the small businesses started in 2014 failed in the first year. Almost half failed within four years.1 But just because it’s difficult doesn’t mean it isn’t worth it. While owning a business is tough, the idea is simple. You invest the money to run the business; therefore, you earn the profit — passively.
- Dividends – Stocks can produce passive income — specifically, dividend stocks. I’ll keep the example simple so kids can grasp it. You buy a stock for $20 that pays a 1% dividend, annually. You now earn $0.20/year in passive income from that stock. Yeah, you’ll probably need more than one. Of course, this is also risky, because you’re counting on the stock to retain and/or increase in value.
- Royalties – This is any money you earn from something you create. Whether you write a book, record a song, or film a movie. Writing a book is the most common way to earn royalties, but of course, the book has to sell to provide passive income, and it’s not always going to be a steady number.
- Peer-to-Peer Lending (P2P) – You lend money to another person or group of people, typically through a lending website. It’s obvious why this is a risky option: people don’t always pay. And sometimes people go bankrupt.
- Unconventional Investments – As the name implies, this could mean many different things outside of conventional investing. It’s anything outside of typical investments that pay passively, through dividends or other arrangements. YouTube stars, who receive advertisement income, would be one example — it’s a business, but not in the typical sense.
When it comes to passive income, think multiple income streams. That’s like diversifying your portfolio, and it’s the most effective way to ensure the income keeps incoming.
Analogy 1: Streams Vs. Buckets
Kids first learn about acquiring money through saving. Think of savings as buckets. You save money, and you keep saving money, so you acquire these buckets of money. They aren’t doing anything on their own, but they’re there.
Now think about earning money. Earning money is a stream — an income stream. The idea behind passive income is to have as many income streams as possible. Again, it comes back to diversity. If one stream dries up, there are the others.
Kids need to know about saving money, and having those buckets, but for true financial freedom, kids need to learn about streams. Use the bucket/stream analogy to show the difference between the money saved and the reoccurring cash flow coming in.
For another analogy, the streams that come in passively are comparable to gardening…
Analogy 2: Gardening
Passive income may seem like an easy concept, but your kids will probably want to know how it’s fair to make money without doing anything in the moment.
Your kids can understand the concept of planting a seed, and growing a tree, or a plant. Passive income is the same thing.
Most passive-income models involve quite a bit of time, and/or money, up front, which turns into passive income over time. It’s about delayed gratification, and hard work now to make your life easier later.
If your kids can get the concept of doing the work upfront to reap the rewards later, they’ll be ahead of almost everyone.
Read: The Wealthy Gardener by John Soforic
How Kids Can Earn Passive Income
Kids have options to earn passive income at their level. They don’t have to wait. And while they may not be rich by 18, they can gain the concept of passive income.
Here are some ideas for kids to earn passive income:
- Candy/Toy Machines – One of the best physical ways a kid can earn passive income is through placing machines in different local business. All you need is a machine, something to fill the machine, and permission from a business to place it. One father taught his son this method with a gumball machine, which led to major profits, especially for a child. Here are a couple examples of machines you can buy straight from Amazon to get started: option 1 (smaller) / option 2 (larger).
- Real Estate – Your child can start saving at a young age to buy their first piece of investment real estate. You can partner with them to make the process go quicker, or let them do it entirely on their own. Of course, you’ll have to do the legal piece and actually buy the property, but if it’s their money, they can earn the cash flow from the tenants.
- YouTube – Plenty of kids are earning money on YouTube. Ryan, from Ryan ToysReview, earns millions this way. It’s pretty easy to set up a camera, buy some toys, and do reviews. There are numerous other things kids can make videos about to earn some cash. That being said, you have to be comfortable with your kid being a YouTube star — with his face out there to the public, constantly. You can also look into some options that don’t involve your child’s face on the screen, like creating stories and acting them out with action figures.
- Blog – There’s nothing holding a kid back from starting her own blog. I have an entire guide on how you can help your kids do it. Blogging isn’t always the passive income people think it is, because it requires a lot of work to keep it going, but if your kid enjoys that, have at it. And the passive income will come eventually.
- Investing – Buying dividend stocks is not out of reach for a child, but you’ll have to help them do it, either in your brokerage account, or in some sort of custodial account. There are no age restrictions on IRAs,2 but you must contribute earned income, meaning your child needs to have money coming in somehow to contribute to one. Teach your kids to invest, at a young age.
- Business – Your child is more than capable of starting a lemonade stand or a car washing service. If he can grow the business, he’ll need employees. That’s where the passive income starts. Don’t set limitations on your kids when it comes to businesses like this, and don’t forget the tax piece.
Those aren’t the only options for kids to earn passive income, but it’s a great place to get started.
Kids are only limited by their mindset and their parents. As their parent, let them think big and dream. Listen to their ideas and see if you can make it work.
When a child gets an idea, there’s unstoppable passion behind it. That passion goes a long way. Let it ride. It’s not common for a kid to earn passive income, but don’t let that stop you from letting your kid try. That should motivate you to be the good kind of different.
Money isn’t everything, and this shouldn’t turn into a life of pursuing money above everything else. The goal is to earn passive income for full financial freedom, and to help others.
If you’re raising a big thinker, you already know she is going to do great things. Passive income is one way to get the freedom that allows her to do those things. It’s a form of exponential growth.
Start planning the passive income today with your kids. See what they want to do, go with it, and see how it plays out. If they fail, great! Let them learn the lesson, and help teach it to them. And then try something else. If they succeed, awesome! Don’t let it go to their head. Instill humility.
Further Book Reading
- Rich Kid Smart Kid by Robert Kiyosaki
- How to Invest in Real Estate by Robert Waller
- Dividend Investing by James Johnson
Last Updated: October 9, 2020
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- M, Mansfield. (2019, May 28). Startup Statistics – The Numbers You Need to Know. Small Business Trends.
- A, O’Shea. (2019, August 12). Why Your Kids Need an IRA. NerdWallet.