Wednesday, 17 September 2014

Passive Income - A Key To Wealth

Creating Passive Income – A Key To Wealth

What is passive income?

Passive income is an income received on a regular basis, with little effort required to maintain it. Creating passive income is one of the quickest ways to improve your overall wealth as it means your money is earning more money. The bigger the % return you can generate the faster your wealth will grow, especially when that income is re-invested to create more income. Let’s look at how your money can grow, let’s assume you invest $1,000 per month into income producing assets for a period of 10 years (total investment $120,000). The examples below show returns at 3% per year, 7% per year and 11% per year, with the income re-invested.

@ 3% returns your account is worth $140,090 and will generate income of $4,202 per year

@ 7% returns your account is worth $174,094 and will generate income of $12,186 per year

@ 11% returns your account is worth $218,987 and will generate income of $24,088 per year

Let’s look at that for a second, by investing $1,000 per month with a 7% return for 10 years you can provide a consistent income stream of over $1,000 per month for as long as you keep the account (assuming the 7% returns continue). At 11% returns a $1,000 per month saving will give you over $2,000 per month for as long as you need it.

So let’s look at some examples of passive income

1. Bank Account Interest. This is interest paid to you by the bank for depositing your money with them and maintaining a positive balance. Currently the returns from bank interest are quite low but they are fairly secure and predictable although by sopping around or using term deposits you may be able to get 3 or 4% per year.

2. Dividend Stock Investing.  What is better than a stock that goes up in value?  How about one that pays you along the way.  That’s the idea behind dividend stock investing: Picking stocks that not only have a high potential to show growth (capital gains) but will also pay you a handsome cut of the company earnings every quarter (the dividend payment).  If you can manage to collect enough shares of these high quality stocks, then you could set yourself up to receive thousands of dollars in annual income for doing nothing more than being a shareholder (now that’s passive income!) 

3. Real Estate Investment Trust (REIT). If you like the concepts of receiving dividends and owning real estate, but would rather not directly own physical property, then an REIT might be a better choice for you.  REIT’s were very popular during the housing boom (as you might imagine), but they lost a lot of steam after prices fell.  However, don’t rule them out as there are still some excellent investment choices available.

4. Bond Ladders or Bond Interest. Bonds have much more stable returns.  That’s because unlike a stock, a bond is a payment of debt where you collect interest for being a lender to a company.  If you can manage to purchase enough bond coupons, you could create a steady stream of passive income.  That is the idea behind a bond ladder: Basically each year you buy one set of long-term bonds with a fixed high paying interest rate and then stagger them over a long period of time.  After a while each year a bond will become due and you can use the proceeds to buy into another long-term bond; preferably at a higher interest rate.

5. CD Ladders. Similar to the Bond Ladder, you could use the same strategy with Certificates of Deposit (CD’s).   In this day and age, online banks seem to offer the best interest rates for CD’s. 

6. Rental & Commercial Property: Renting out a house or shop/office is one of the oldest passive income ideas. You not only collect monthly rent and make a profit from it, but you can also use the rent to pay off the actual mortgage of the property. This type of investment requires more time to manage than the above ideas, however, If that bothers you, there are also rental management companies you can hire to take care of the dirty work at a cost. The only thing to keep in mind is that the risk is that much higher if you struggle to find any tenants and the property can be hard to liquidate should you require your money back and the initial purchase costs are significantly more.

7. Business Owner: Owning a business that you do not work in can also be a lucrative way to generate passive income – if you choose the right one! Many of my clients own small hairdressers, restaurants, and niche companies where they are either an investor and thus receive a share of the profits or are the full owner but install managers to run thing day to day. The returns can be very good but it does require more time and some business knowledge.

To Summarize

There is no better time to start than now. The simplest way to start building a passive income portfolio is to buy some high quality dividend paying stocks or bonds.

As always, if you have any questions, feel free to contact me directly.

Have a great day, Andrew Lumley-Holmes.

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