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Many years ago, when people retire from work, they receive a watch and a pension.
It doesn't work like this anymore.
Today, many adults jump from employer to employer until they quit working. In doing so, they forfeit getting the watch as a symbol of loyalty. Worse, many of them end up without the pension that normally goes with long years of service.
Fortunately, any individual can have a good retirement plan that would supply a steady stream of income later in life. With good planning, this may provide a good income during mandatory retirement or even during early retirement.
Passive Income Begins As Savings
It's obviously easier and more enjoyable to spend than to save. If saving was easy, all of us will have fat bank accounts by our 30's. However, saving money is really difficult to do.
There are many goals for saving. A person may want to save money to buy a property that he can utilize to generate income. However, there is one strong motive why people save. It is to have enough money to do what you want without borrowing or working for it later.
The Difficult Journey To Freedom
It may appear to be a really good dream but it's not as easy to achieve as it sounds. We wish there was a formula or guide how to do it like a 401K By Age chart. We would just have to look at it for instructions on how much to save up to what date. After that, we would just sit back and wait for financial freedom to come marching through the door.
Alas, saving money is but the first step in building passive income. Many people who already have the money discover that they haven't the slightest idea what to do with it. Where to invest the money is even a more crucial step in the process.
If you can max out your 401K or IRA and save an additional 20% or more, you can start rocking.
That is, assuming that you've paid all the contributions and taxes and other stuff. If you are planning for earlier financial freedom, say in your 40's or 50's, there's a different approach. You have to go towards more after-tax savings and investments. Remember that you need to wait until you're 59.5 to withdraw from your 401K or IRA without paying penalty.
What Are The Most Common Passive Investments?
Here are some ideas for generating income in seven general categories. (Note: none of them involves putting your money in common stocks.) But, as in any investment, remember three important things: capital, time and risk tolerance.
How much amount of your money are you willing to invest? What is your overall time frame? What is the maximum risk level are you willing to put up with?
You must have a clear and definite answer to these three questions before you make your move.
1. Dividend Stocks
This is probably the easiest way for an investor to earn passive income. Technically, they pay you for just owning the stocks. When the companies represented by your stocks make a profit, they give some of them back to their stockholders. This called a cash dividend. You can reinvest this money to buy more stocks or if you need to pay or buy something, receive it in cash.
Dividend yields are not fixed. They vary from year to year and they can fluctuate significantly depending on the underlying companies' performance. If you are unsure which dividend stocks to buy, you can stick to the ones with the dividend aristocratic label. This indicates that the company has paid increasingly higher dividends for the last 25 years.
2. Fixed Income/Bonds
Interest rates have been going down for the last 30 years but bond prices have been going the other direction. The 10-year yield, the risk-free rate stands in the neighborhood of 2.8%. The Federal Funds rate is going at 1.5% and experts expect it to continue to go higher beyond this year. These two indicators somehow assure investors that the rates are not about to go down any lower. In fact, analysts expect the interest to stay low for a long time. Take the case of the interest rates in Japan. They are in the negative range because inflation has risen higher than the nominal rate.
Bonds could be an investor's defensive allocation in his investment portfolio. If an investor holds a government bond straight to maturity, it would be to his advantage. He can get all his coupon payments and the principal back. Like stocks, there are thousands of different bonds available in the market. Therefore, any investor must choose the ones that best suit his requirements.
3. Real estate
Although the industry has had some major setbacks several years ago and a few rocky stretches, it remains a good option. It is still a preferred choice among investors to generate long-term returns. Real property investment is one of the more stable ways to earn a regular income. Of course, in the beginning, you will have to put up a 20% down payment to purchase a property.
Although it could be a significant amount if you have been saving regularly, this might not be a problem. Once you get a tenant for your property, you don't have much to do after. Maybe a little maintenance work now and then but it's mostly just waiting for the rental checks to clear.
If you don't want to concern yourself with the day-to-day stuff of property management, there is still another option. You can simply invest in real estate investment trust (REIT). REIT's payout 90% of their taxable income to investors in the form of dividends. That's a pretty good advantage for an investor. The downside is, the IRS considers this dividend as ordinary income subject to tax. If you are an investor in a higher tax bracket, this tax could have a significant impact on your expenses.
Real estate crowdfunding might be a solution.
Here, investors can choose between equity or debt investment in a wide range of property types. Real estate crowdfunding companies invest in residential, commercial, condominiums and mixed-use projects in many states. Investors get the tax advantage of direct ownership without the usual burdens that come with owning an active rental property. You can't get this benefit with a REIT. What's more, you can even charge the depreciation expense against your income.
4. Mutual Funds (customized for monthly income)
The concept of living off your investment is not a new idea and is a dream of many people. Multiple financial companies offer products designed to offer a sufficient monthly income for investors.
If you are interested to invest in mutual funds, you need to check the fund's stock to bond ratio. Many funds will include both stocks and bonds in their portfolio to produce a monthly return. However, if the fund leans more towards stocks than bonds, it is much riskier. Funds that carry the less risk would be those that invest mostly, or even purely, in bonds.
Mutual funds with more stocks would normally produce higher returns than funds with more bonds. You must decide based on your tolerance of risks in relation to your overall financial targets.
5. Peer-to-Peer (P2P) Lending
The peer-to-peer (P2P) lending industry is comparatively a young industry but it has grown dramatically because of technology. It offers investors an opportunity to earn passive income while helping others. Plus, it is relatively easier to do and understand.
For one, investors will find it is easier to come in compared to other types of investments.
For example, the 2 biggest P2P platforms, Prosper and Lending Club, accept initial investments for as low as $25. They also allow non-accredited investors to open an investment account with them. The Jumpstart Our Business Startups (JOBS) Act allowed both accredited and non-accredited investors to invest through crowdfunding. However, P2P companies still maintain their own policies on their platforms. These two examples have opened their doors to all comers.
Good ROI, Higher Risk
When it comes to returns, P2P lending can be profitable. More so for investors who are willing to take more risks.
Loans via P2P pay certain interest to a bunch of investors. Investors can get bigger interests from borrowers that the P2P platforms have classified as bigger credit risks. Returns go anywhere from 5% to 12%. As an investor, all you need to do is send your money to through the platform, wait, and then collect.
6. Certificates of Deposit (CDs)
Gone are the days when CDs would produce a decent 2%+ yield.
Today, if you can find a 5-7 year CD that pays anything over 2.2%, you've stumbled upon a gold mine. CDs remain a simple choice because there is no minimum net worth or annual income to meet, unlike other options. Other alternative investments still require an investor's accreditation before one can put in some money. Anybody can just walk into his bank and open up a CD with their choice of the maturity date.
On top of that, insurance can fully cover your investments in CDs so there's hardly any risk. The FDIC insures up to $250,000 per individual deposit and $500,000 for joint accounts.