How to Turn Freelance Income Into a Robust Passive Income Stream

3+ Ways Freelancers Can Earn Passive Income

Are you a freelancer or solopreneur consultant?

Do you worry that, when you’re not working, you don’t get paid?

Find out how a freelancer can create a passive income stream for the future.

A recent survey by the Freelancers Union found that 53 million Americans are now freelancers. In fact, one in three workers are freelancing.

The difference between many freelancers/solopreneurs and salaried workers is that if you receive a salary and you want to take a break, grab a soda, take a quick walk to clear your head, you’re still getting paid. If you’re a consultant or freelancer, and you’re not working, then you aren’t getting paid. 

Consider the pay-per-job worker. A freelancer is not that different from a dentist or a clinical psychologist. If you’re not serving your patients or clients, then you’re not getting paid. And with some professionals, such as the psychologist, once that patient gets better, she probably won’t come back and you need other patients to replace the one that improved. That makes going on a vacation a big deal. There’s no two weeks paid vacation for the independent contractor!

I’ve been doing a lot of freelance writing recently. Part of me is thrilled to have a variety outlets for my finance writing. But another part of me-the aging part-is thinking about the idea of a passive income stream. After all, I’m staring down the barrel of retirement and although I love to work, at some point, I’ll slow down and eventually stop.

What is Passive Income?

“Earnings an individual derives from a ren​tal property, limited partnership or other enterprise in which he or she is not materially involved. As with non-passive income, passive income is usually taxable; however it is often treated differently by the Internal Revenue Service (IRS). Portfolio income is considered passive income by some analysts, in which case dividends and interest would be considered passive.”~Investopedia.com

The IRS.com is quite strict in its definition of passive income; a rental activity or business in which the individual doesn’t materially participate. For the sake of argument, this article takes a broader view of passive income. 

Personally, the IRS has probably never owned rental real estate, because there is nothing ‘passive’ about it. When a tenant calls at 2:00 in the morning about a broken pipe, you can’t lay back and remain ‘passive’ you must go out and repair it yourself or see that a plumber shows up, while you pay time and a half.

In fact, there may not be any source of income that is truly passive, as almost every business activity, rental real estate, investing, or even affiliate marketing requires a certain amount of work. 

So, let’s tweak the definition of passive income to mean receiving ongoing income from a single activity, performed previously, that requires a small amount of present oversight.

Potential Passive Income Activities

Rental Real Estate-Buy a rental home or multi-family property and rent it out. Receive income payments.

Royalties-Write a book, sell copies, and receive ongoing income payments from the sale.

Stock Dividend Payments-Buy a stock and receive a percent of the value of the stock price in cash or additional stock shares payment.

Investment Capital Appreciation-Buy a stock, bond, or mutual fund and sell it at a higher price for a profit.

Bond Coupon or Interest Payments-Buy an individual bond or bond fund and receive interest or coupon payments.

Government Securities-Invest in one of the government securities such as bonds, notes, bills, TIPs, I Bonds and zero coupon bonds and receive an interest payment. (Except with zero coupon bonds, which are bought at a discount.) 

Invest in a Business-Invest in a share of a business in return for on-going financial payments.

Peer-to-Peer Lending-Lend money and act as a banker to others in need of funding through one of the social lending platforms such as Prosper or Lending Club. Receive interest payments based upon the credit worthiness of the borrower.

Become an Affiliate-Sell someone else’s product or service and receive a commission on the sale.

Can Consulting or Freelance Work Create a Passive Income Stream?

It can be done, but it takes some effort, mental effort. First, you can’t spend all that you earn or there won’t be any money left for that coveted future passive income stream. The more you can ‘not spend’ your earnings, the greater the possibility that you can turn your freelance income into a passive income stream.

If you’re a freelancer/solopreneur/consultant, then you first must set up a plan to divert some of your income away from living expenses. One strategy, if you income fluctuates, is to set a minimum cost of living and divert any income above the minimum into a pool to use for future passive income streams.

Let’s look at the case of the married couple, Jillian and James Jones. Jillian has a great corporate job, earning 6 figures. James is a solopreneur with an irregular income stream. James designs websites and only gets paid when he does a job. Some months he makes $5,000, some months he makes more and others less. James and Jillian are in their 50s and thinking about the future. Their kids are out of the house and they have several options about what to do with their income:

1. They can spend all of their income.
2. They can give some of it to their kids.
3. They can use a good portion of their income to create a passive income stream for the future.

Jillian and James can live solely on Jillian’s income. At present, they don’t do this, but they could. They would need to make a decision to cut back on their standard of living first, in order to free up some capital to create a future passive income stream. Currently, Jillian and James are spending most of their income, with the exception of a contribution into Jillian’s workplace retirement account. They consider James money their discretionary funds and take lavish vacations and eat out at expensive restaurants.

To create a passive income stream as a freelancer, Jillian and James’ behavior would need to change. They would have to commit to scaling back their lifestyle.

How to create a passive income stream with freelance income:

Like most lifestyle adjustments, you need to start first with the desire to spread out some of your current earnings over your entire life. Jillian and James haven’t thought much about that before. As the age, they’re becoming more concerned about their financial future. This anxiety is motivating the couple to change.

Let’s assume they could free up $500 per month to create a passive income stream for the future. Here’s how to use that money to earn more money later.

Passive Income Idea #1-Invest in Real Estate

Although you could buy real estate with the additional monies and rent out the property, my experience is that managing rental real estate can be a lot of work for a retiree. But there’s another way to build up a passive income stream with real estate.

A real estate investment trust or REIT is a company that owns real estate. The REIT company gives ordinary investors the opportunity to invest in portfolios of many different real estate holdings; apartments, shopping centers, hotels and more. Instead of keeping all of the profits from the real estate ownership, the REIT company sells investors shares of the REIT and in exchange for an ownership percentage you receive a percentage of the corporate profits in the form of a dividend.

“Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends. “~REIT.com

For a slice of the entire REIT investment pie, Jillian and James might invest the $500 per month in a REIT fund such as Vanguard’s REIT Index Fund Investor Shares (VGSIX). Had the Jones family invested a lump sum in the Vanguard REIT index fund in 2006, their investment would have doubled by 2016. Since it’s inception in 1996, this REIT index fund averaged an annual 10.95% average return.

Take James’ $500 monthly investment starting at age 50. If he reinvests all the dividends in this fund until he turns age 69, his REIT fund account will be worth $215,502 (given a 6.61% annual rate of return). Assume at age 69 he stops contributing any money to the REIT fund and takes the dividend payments as a passive income stream.

Assume that the income payout on this $215,502 REIT account lasts for 20 years, then James can expect an annual passive income amount of $19,729 (assume continued growth of 6.61% during retirement) from age 69 through age 89, at which point the account is depleted.

And that’s how a freelancer can build up a passive income stream.

Passive Income Idea #2 – Be a Banker 

With banks slow to lend to small businesses and credit card rates sky high, a new industry has emerged, social or peer-to-peer lending. At the forefront is Prosper Lending. Here’s how it works. You open an account and transfer in some money. Then you choose borrowers from the Prosper lending platform that you want to lend to. The borrowers are listed with information about their loan request and their credit worthiness. 

Investors! Earn great returns with Prosper.com peer-to-peer lending

I’ve invested with Prosper for five years and my average returns are a tad shy of 7.5% annualized. The platform is designed to minimize the risk of lending to individuals by encouraging investors to allocate only $25 to each borrower, thus if one buyer is late making her payments, your entire investment in Prosper isn’t compromised.

The Jones’ could take all or part of their $500 savings each month and invest it with a peer-to-peer lending platform and continue to reinvest the interest payments in additional loans. As interest rates rise, the expected returns on their $500 per month might rise as well.

To turn this investment into an income stream, upon retirement, the Jones could stop reinvesting their interest payments and simply take the cash from the borrowers loan payments. This creates another stream of passive income.

Passive Income Idea #3 – Become a Partner

What is a ‘Master Limited Partnership – MLP’

“A master limited partnership (MLP) is a type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP’s cash flow, whereas the general partner is the party responsible for managing the MLP’s affairs and receives compensation that is linked to the performance of the venture.”~Investopedia.com

A master limited partnership may offer high dividend payouts from a variety of types of underlying investment activities. Similar to the ideas in the peer-to-peer lending sphere, because these investments are risky, it’s a good idea to invest in a diversified exchange or mutual fund of many master limited partnerships. You get the benefit of a high yield and less risk.

Many MLP funds focus on one industry, such as the energy sector. There are others that are more diversified and thus, less risky. For example, the  ZMLP Direxion Zacks MLP High Income Shares ETF uses a proprietary method to select a group of 25 MLPs with potential to yield and outperform the S&P 500 and other benchmarks. This ETF also offers a higher than market yield, which when reinvested, has the potential to grow your initial investment substantially and throw off a respectable passive income stream in retirement.