The way many people earn money is by going to work which then pays them for their time spent working in the form of a paycheck. Working is you "selling your time" for a set amount of money. Working often belongs to a bucket of income called "Active" income which is where you have to spend time and effort in order to make money.
What I want to discuss today is the concept of PASSIVE income and why it is important and could be life changing for you down the road.
You can think of passive income as income that is "automated" or takes very little of your time in order to earn. Passive income is often earned 24 hours a day/7 days a week/ 365 days a year! Sounds great right? Well it is.
Starting now and building up multiple passive income stream can be one of the most life changing decisions that a person ever makes. This decision is especially important when you are young as starting young gives you more time to build up your passive income stream and will allow you to reap the rewards earlier!
So now you may ask well what kinds of things are considered a passive income stream? The answer, well is basically anything that earns money for you with very little on going effort to maintain that income stream going forward. Some common sources of passive income streams are listed below:
- Real estate - Real estate can be a bit more active and hands on if you manage a property yourself but if you have a property manager or invest in real estate syndication's (funds) this income becomes much more passive as the only significant time needed is the upfront time spend evaluating the investment and doing your due diligence before investing. A real estate syndication or a real estate fund is an investment that raises money from investors in order to purchase an income producing real estate asset such as an apartment complex. Once the money is raised and the asset is purchase the limited partners or investors have little to no additional work that needs to be performed on their part as the general partner or sponsor manages the project from then on. These types of investments usually produce monthly cash flow from the rents received that is distributed to the investors on a periodic basis (monthly, quarterly). An additional way that these investments earn passive income for investors is at the end of the fund when the property is sold the investors usually receive a portion of the profit on the sale which can be quite large in some cases. I recently had a deal close that provided me with an 8% return from cash flow and then an 80% split at the time the apartment complex was sold! So my initial investment in the fund was not very high at $1,000 but I received my 8% preferred return for around 2.5 years and then the property was sold and I received a large distribution upon sale. Overall my cash flow from my $1,000 investment was $1,000 in principal returned and an additional $1,020 returned in the form of monetarily distributions and a large distribution from the sale. This investment performed extremely well and one should not believe that they will receive these returns on all real estate investments. A more common rate of return is between 7% and 15% on an annualized basis.
Obviously my single $1,000 investment was not life changing but imagine if you had 100 of these investments ($100,000 total investment) producing an 8% preferred return monthly! This would mean you would receive $8,000 annually and approximately $666 monthly! That would be a nice supplement to your income!
Now real estate is not the only type of passive investment out there it is just one that I like to invest in frequently. A few other types of passive investment could include:
Pear to peer lending - sites such as lending club essentially allow you to become the bank and lend to others for interest income that is paid monthly.
Investing in stable dividend paying stocks or dividend focused mutual funds - these investments typically pay dividends quarterly to the shareholders. Dividend rates vary widely based on the risk of the stock or fund but you will typically be able to find rates in the 4% to 8% range. There are stocks that pay higher dividends but they do not come with out additional risk. Usually the higher the dividend the higher the risk as there is always risk that the company will cut its dividend if it does not have strong financial performance. Investing in dividend stocks is a great way to supplement your passive income stream as after the initial purchase their is little to no work required to receive the pay outs!
Bonds - Bonds take many forms (tax exempt bonds, government bonds, long-term bonds, short-term bonds etc.) but what they all have in common is that they pay interest to bond holders. This interest can be paid out over varying terms depending on the bond but it is a great way to build a passive income stream.
Debt funds/partnerships - These types of funds can be a great way to build up a monthly cash flow that is passive. These types of funds typically invest in numerous types of income producing debt such as short term financing for real estate projects, mortgages, business loans etc. The rate of return again can vary as the level of risk goes up or down. There are a few platforms that I use to invest in real estate notes funds which typically fund fix an flip projects, new development, hold long-term mortgages etc. One platform I use is Fundrise which has a variety of real estate funds available. I have received on average an 8-10% cash flow from their funds over the past few years. Another real estate platform I use is Realty Mogul and they offer a few funds but the one I am invested in is the MogulREIT I and it offers an 8% distribution to investors. Another site that I use is AHP Servicing which has a fund that invests in non-performing mortgages at a discount and pays investors a preferred return of 10% monthly. Groundfloor is a great site that I use for short-term real estate loans as they have low minimums of just $10 per loan and my average return has been above 10% annualized.
Become a silent partner in a business. This is where you put up money and have little to no involvement in the business but would receive a share of its profits.
An online savings account or certificates of deposit. This is one of the least risky options but it also pays the lowest returns. Right now I am getting a little over 2% in my online Goldman Sachs savings account. I typically use these accounts for my emergency fund.
As you can see there are many options that allow you to invest and receive a passive income stream going forward. One of the most important things to consider when choosing an option or options is the level of risk that you are willing to take on. Some of the investments I mention above are much more risky than others. The more risky means that you typically receive a higher rate of return but also take on more risk that the investment will not perform as well or be as predictable.
So how do I start?
The first thing you should do is assess the level of risk and return that you are looking for. Once you have determined that only then can you do some research and decide which investments are right for you.
A good way to build up a passive income stream is automate your investment to say xxx amount per month so that the money goes in each month and increases your investment and therefore increases your cash flow each month! This will allow you to build up your passive investments over time which will keep increasing your cash flow monthly that you will earn. Eventually if you have enough invested you may be able to become financially independent, meaning the cash flow from your passive investments meets all of your needs to live and would give you the freedom to stop working or work less if that is what you want to do.
If you can build up your passive income stream so that it is $10,000 or more annually you will have much more freedom in your life. You can take more vacations, possibly work less or at a job that pays less but you really enjoy, spend time giving back to the community through projects that you believe in and the list can go on and on!
Basically starting to build up your passive investments and income stream when you are young and continuing to do so though out your life can give you the flexibility and ability to do many things that you would not otherwise be able to do if you are only making money from an Active income source such as a paycheck from a job!
If you are able to build up a portfolio of passive investments worth $300,000 down the road and earn an average return of 5% that is $15,000 annually or $1,250 monthly. If you earn an average of 10% those returns jump to $30,000 annually and $2,500 monthly. No you may be thinking shit that is a lot of money and I can never get there. That is not true! I started investing when I was 16 and have been doing so since investing around $5,000 or more annually for most of my life up until after college. Once I was working full time and making more money I started investing more but the point is to consistently put away as much as you can while you are young. Now my portfolio is worth over $200,000 and I am 29 years old! I worked hard all though out high school and college having 2-3 jobs while going to school and now that all is paying off for me!
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This article is for informational purposes only and should not be considered legal, accounting, investment, financial or tax advice. Please consult your own adviser before making any sort of investment as some of the investment options discussed are not suitable for all types of investors and can complicate your tax situation.