Passive Income To Consider To Build Financial Dependence
By: Ian Golightly MBA
Suppose you decide to achieve financial freedom before the traditional retirement age (65 and up). In that case, you’ll need a passive income strategy. Passive income in its simplest form is having your money work for you. The internet advertises passive income in a way that you sit on the beach, and money will be wired to your savings account. Before that happens, it is going to take work and time to get to that point. In the beginning stages, it’s going to take money, work, and time. These three ingredients are critical, but you will be on your way to financial freedom with patience.
Many personal finance consultants would say that passive income is the holy grain of personal finance. The overall goal is to generate enough passive income to cover the cost of your lifestyle, which would result in a free life. You’ll have the ability to do whatever you want based on your time. The way to generate useable passive income is to build a taxable investment portfolio.
Traditionally we’re taught to max out retirement accounts like 401K, 403B, Roth IRA, etc. These options are great, but you cannot reap the benefits until you’re near retirement age. The approach to reaching financial freedom is to achieve it as early as possible.
Saving Is The Best Passive Income:
The most important reason to save your money is to give you the option to do what you want, when you want, without having anyone telling you what to do. That is the authentic way of financial freedom.
To be financially free, you’ll need to save money, and it’s, unfortunately, the first step to building a passive income. One of the most challenging tasks is to invest, to give you the most return over time. Having the ability to max out your retirement (401K, Roth IRA, etc.), you should challenge yourself to save 25%+ of your after-tax income. As an ultimate goal, you should try to save 40% of your after-tax income or more.
Your taxable retirement portfolio is the one thing that will allow you to reach financial freedom. The portfolio should enable you to liquidate passive retirement income. Your retirement account is not supposed to be touched until later in life without hitting a penalty. Ever since the Sars-2-Covid pandemic, it has made millions of people revaluate their finances. Moving forward, you’re in control, and it will be up to you what your results will be.
As you read below you find some passive goal options that you should consider. There are a few things that you’ll need to consider for each option:
- Risk: Higher the risk greater the return and lower the risk the small the return.
- Return: What potential are you able to get cash out on.
- Feasibility: Are the requirements worth the risk and return.
- Liquidity: Are the funds easily accessible from your return on investment.
- Activity: How much sweat equity will be needed.
- Taxes: Uncle Sam likes to collect, and each passive income route may have different tax rules.
Private Equity Investing:
Private equity investing can provide a substantial source of capital if a suitable investment is made. If you’re able to find the next Netflix, Uber, etc. the returns will blow any other passive income investment. In reality, finding the next stock or being allowed to invest in an IPO will be tough. These opportunities, however, do arise for investors who are the most connected.
Here are a few examples of private investments:
- Real estate funds
- Private companies
- Public companies (stocks)
- Hedge funds
If you plan to invest in a private company, it will be the least liquid option. Investing in a private company is not like a public company where you can sell off the stock. Your investment may be locked up forever with zero dividends or distributions. Traditionally, private investments are only accessible to accredited investors. An accredited investor is an individual who has an annual income of $250,000 or $1M net worth excluding primary residence.
Private equity investing is a long-term strategy and should be perceived as a 3-5+ year investment term.
The P2P lending phenomena started back in San Francisco in the mid-2000s. The goal of P2P lending is to hurdle over the banking system to help denied borrowers get loans. In the real estate sector, you’ll find real estate investors who are willing to fund real estate projects for a certain amount of equity in the deal. The great thing about being a peer-to-peer lender is that you act as the bank to set what APR you would like.
It’s common to see a 5%-7% annual percentage rate (APR). There are many factors to consider when dealing with P2P return on investment and heavily depend on how accessible private lenders are. Two of the most considerable risks with P2P are when borrowers don’t pay back investors or default on their loans. Investors are acting like a bank and will face just as much risk as a bank would. If your gut has a funny feeling about a deal, then it may be better to follow your instincts.
Truthfully, I’m not a fan of P2P because of the high risk associated with it.
Certificate Of Deposit (CD):
Many moons ago, CDs were a top choice to invest your money into because they could produce a 4%+ yield. It would be tough to find a 5-7 year term for a CD to provide a 1.5% return. One advantage to purchasing a CD is that there are no minimums to start.
You can go into your local bank and open up a CD for your desired duration. The risk is so low that your CD is FDIC insured for up to $250,000 as an individual or $500,000 per joint account. Because of the significant drop in interest rates, you’ll need to build an enormous net worth before retiring. As a result, you’ll need a tremendous amount of capital to generate an impactful passive income. Since interest rates are historically lower, savvy investors should be taking advantage of the opportunity.
If you are a homeowner, refinancing your mortgage can help you save money. It will also allow you to take on debt to enable you to invest in higher-yield investments.
I’m slightly biased, but this is my favorite strategy to build wealth. As a licensed Realtor and also an active real estate investor, I’m a firm believer that you can create a significant amount of wealth by investing in this route. For example, my first investment property was a perfect fit for my budget since I would take out a 2nd mortgage. When you invest in a property, make sure that it fits your budget. The seller for my investment property was a distressed seller due to family problems, so I was able to get the house 40% off the listed price! After a year of owning the property and because of the hot real estate market in the area, the place also went up in value by $25,000.
If you plan on getting a rental, make sure you have done plenty of research before you down that road. There are plenty of books and also Facebook groups to get involved with. There may also be a real estate investing group in your local area. When dealing with tenants, you’ll want to make sure you’re providing the best customer service. If you don’t plan on using a real estate management company, don’t be surprised to get late-night phone calls from your tenants when things go wrong. Having a great real estate lawyer is also essential these days.
Real estate also provides excellent tax incentives through a 1031 exchange that allows you to exchange your property for another property without paying any capital gains. If you lived in a property for 2 of the 5 years (primary residence) or own property for 5 years, the first $250,000 in capital gains is tax-free per individual. On the other hand, if you are married and both are on the title, you are eligible to receive $500,000 in tax-free gains after the sale.
If you own rental property, you can take non-cash amortization expenses to reduce any rental income tax. I believe owning property in general over the long term is one of the best options.
Create Your Own Stuff:
Creating and producing your own product is a great strategy to produce a steady flow of income. If you don’t know how to do the nitty-gritty things, there are freelancers out there that can help. Some things that you can produce is a blog like Wise Gravy, e-book, e-course, stock photos, and so forth.
Coming out with your own product is a great avenue to pursue because of the high margins. The cost of entry is very minimal, and the profitability can be limitless. You’ll want to make sure you update your product when it is needed.
*If you are thinking about building an E-course, Thinkific is a great platform to build your curriculum there.
Stock Market: Dividend Income
One of the best ways to grow your passive income is through dividends when you purchase a stock. The most common stocks to look at are S&P 500 companies. These companies are the ones that show consistency in dividend payouts. So let’s talk dividends and choose easy numbers to follow. Suppose a company earns $1 a share and decides to payout $0.50 in the form of a dividend. In that case, that is a 50% dividend payout ratio. Companies that pay out dividends to their investors tend to be more mature within their sector and have already passed their catalytic growth stage. These stocks tend to be less volatile.
Your older companies like GE, Coca-Cola, etc., are companies that usually have stable dividends over time. FinTech, BioTech, Tech companies are considered growth stocks since they pay almost zero dividends. Companies that are public and considered a growth stock typically take their profits and reinvest the money into their company for more growth. Investors can make a lucrative living investing in a growth stock. Still, they can also lose it very quickly due to volatility in stock trading.
If you are a new investor, you should consider investing in an ETF. An ETF allows investors to invest in a handful of different companies within a sector. So if one company’s stock declines, the investor wouldn’t feel a significant impact versus if they invested in one company and their stock started to slide.
Passive income comes in many forms and there isn’t a road map for the journey. Each option may be better for one person and not another. The most important step is to just start. The bottom line is that no one cares about your money and what you do with it, but you’re the only one that should care.