The No. 1 Way to Use Passive Income

There are lots of ways to earn passive income. Putting money in high-yield savings accounts is one easy option. You could also invest in stocks that pay dividends or create a product to sell, such as an online course.

Once you're making passive income, you also need to decide what to do with it. You could use it as spending money -- there's nothing wrong with that. But if your goal is to improve your finances and build wealth, there's a better option.

Make the most of your passive income

The best way to use passive income is to invest it -- or reinvest it, if you're earning passive income through investments. You're probably already able to cover your bills with money from your regular work. If you don't need your passive income for anything pressing, why not invest it so it can grow?

There are a few ways you could do this. If you're earning dividends from investments, you could reinvest them in the same stock or investment fund. Many online stock brokers give you the option of automatically reinvesting dividends so you don't need to do it yourself. I use this feature with my own portfolio because I'd rather have my dividends reinvested than sitting around as cash.

If you're earning interest in a savings account, you could just leave it there. You'll then earn compound interest -- interest on top of the interest that has already been added to your balance. Another option is to transfer that interest to a brokerage account and invest it.

Another option: Reinvesting in your business

Some people also earn passive income, or semi-passive income, through businesses. Maybe you have digital products you created and now sell, or you own rental properties and have partnered with a property management company to handle most of the day-to-day work.

You could take this money and put it in one of the options mentioned above: stocks, investment funds, or a high-yield savings account. But many business owners prefer to reinvest money in their businesses for greater growth.

The classic example is using profits from rental properties to help finance additional rental properties. I've only done this in Monopoly, as I have zero interest in being anybody's landlord, but it seems to work well for some people.

This strategy isn't limited to real estate businesses. If you're making money from an online course, you could use that money to make your next one bigger, better, and more profitable. With most businesses, investing more money is one of the keys to expansion.

How investing passive income could pay off

Let's say you've found a way to bring in $200 in total passive income per month. Definitely not enough to quit your day job, but there's a lot you could do with that money.

For example, you could follow the advice above and invest it. If you want to invest in the stock market, S&P 500 index funds are a popular choice. The S&P 500 is an index of 500 of the largest publicly traded companies on U.S. stock exchanges. Historically, its long-term average return is about 10% per year.

After 10 years, that $200 per month would turn into $38,250. After 30 years, you'd have $394,786 from a total investment of $72,000. That's nearly $400,000 more in your retirement savings.

It's exciting to start earning passive income. I know it always makes me feel good to see the interest payments in my savings account and dividends from my investment portfolio. If you're looking for a smart way to use your passive income, investing it is one great option.