The Pleasure And Rewards Of Passive Income

A much-lauded strategy for building wealth and retirement is passive income. It is a smart and efficient way to build wealth during active employment as it does not require much personal participation and acts as a buffer should the main income source be affected. In retirement, passive income fortifies one’s financial position providing resilience against shocks, financial or otherwise.

But what exactly is passive income?

Simply stated, it puts money into your pocket without much ongoing commitment after the initial set-up. It is often described as making money while you sleep or letting your money work for you instead of the other way round. Not all passive income are created equal as some requires truly zero ongoing effort while others need some occasional effort. 

Passive income is how I managed to retire at 48, providing me with a bigger and better life in retirement. The 5 passive income streams I rely on are:

1) Rental Income

Buying investment property to rent out for monthly rental income is one of the most proven and reliable way of earning passive income. It is my wealth accelerator of choice, by far giving the highest returns compared to other asset classes within my portfolio. Depending on location (country, city) and the type of property (commercial, residential), the returns range from 6.8% -13.5%. The wonderful thing about rental income is the regularity of cashflow, allowing one to fund living expenses or re-invest to earn more returns, creating a snowball effect. However, quite some effort is needed both upfront as well as ongoing. 

Effort required: 

• Finding the right rental property
• Financing the property, own money and/or mortgage
• Initial renovation and fittings to make it fit for rental 
• Finding tenants and ongoing management of tenancy issues
• Upkeep and maintenance during or in between tenancy
• Managing expenses and administration such as insurance, taxes, association matters etc.

REITs – Real Estate Investment Trusts 

If you are looking for less hassle, due to a full-on job or family demands, a highly recommended alternative is REITs, which are collective investment vehicles that pool funds from investors to purchase and manage the acquired property for rental income (primary) and capital appreciation (secondary).

The set-up of REITs is such that up to 90% of income has to be distributed as dividends to investors after netting management fees and related property expenses such as insurance and taxes.

Besides being tax-efficient, REITs provides instant diversification by geographical and property type:  retail, industrial, commercial, hospitality, healthcare, data centres and infrastructure. Most of my REITs are in Singapore, which offers a good range of REITs and dividend income is not taxed in Singapore. 

Due to the pandemic impacting some industries severely eg. hospitality and retail, my REITs dividend yield in the past year has been reduced to 2.6% – 7.5%. Still very decent return for highly passive investment with minimal ongoing effort. Unlike rental income, which is collected monthly, dividends from REITs are distributed quarterly or semi-annually.

What I like about REITs, in addition to its highly passive nature, is that the underlying assets are bricks and stones, the geographical reach and property mix that is not viable for an individual property holder to achieve. 

Effort required:

• Selecting the right REITs, highest dividend yield is not necessarily the best.
• Corporate actions as needed.
• Portfolio rebalancing annually.
• Keeping tab of ongoing market, economic and/or political news.

Income Stocks 

Owning dividend paying stocks is another highly passive way to earn regular dividend income with little effort once an income portfolio has been constructed. Dividend-paying stocks are typically mature companies with stable business model and are profitable, usually in energy, utilities, infrastructure and FMCG.

Effort required:

• Selecting the right dividend-paying stocks (min 12 for risk mitigation)
• Decision when rights/warrants are being issued.
• Reading company annual reports and being aware of business updates.
• Portfolio rebalancing at least annually.

Index Funds & ETFs

Index funds and ETFs (Exchange Traded Funds) are constructed based on a subset of the broader financial market such as S&P 500 (500 biggest companies in US), STI (30 largest funds listed on the Singapore stock exchange), specific sector (healthcare, technology etc), market maturity (developed, emerging markets etc) or commodities (gold, oil etc).

They mimic the entire subset of the market that they are set up to follow, regardless of performance and are thus passively managed. Although similar in set-up and both may pay dividend, they differ in:

Liquidity – ETFs can be traded throughout the day during  markets hours while index funds are valued only at the end of each trading day.

Transaction – ETFs can be bought and sold on stock exchanges while index funds are transacted via the fund company or broker. 

Fees – ETFs are lower costs compared to index funds. 

Effort required:

• Identifying the right funds or ETF to buy

Peer-to-Peer Lending (P2P)

One of the FinTech offerings created to fill the gaps where traditional banks do not provide, ie funding the ‘un-bankable’, defined as lack of stable income, assets or creditworthiness. P2P lending, also known as crowdfunding, pool funds by large groups of investors to lend to small-to-medium size businesses, start-ups or individuals. The lending and borrowings are facilitated and enabled through a company which takes a cut on the interest.

Lending made to individuals tend to be unsecured so risk of default is high but the idea is that everyone chips in small amount to limit risk exposure to individual investors. 

Loans to small-to-medium sized companies may be secured, if not fully then partially, with invoices or directors’ guarantee, offering some recourse in case of default. 

Since 2017, I have been investing in P2P via a Singapore outfit coordinating loans to small businesses, with interests rates between 9% to 12% for loan duration from 3 to 12 months. After deducting 15% fee, net interest earned is between 7.5% to 10.5%, not bad for clicking a few buttons on an App. Loan deals are broadcasted and participation can be automated via auto-invest feature with pre-specified criteria such as borrower’s industry, interest range and investment amount. 

Effort required:

• Assess fact sheets of borrowing company for participation decision.
• Monitor monthly interest earnings.

I’ve tried other means of passive income such as AirBnB rental in Holland but the hassle and damage to the property was not worth the income differential compared to long-term rental. Tourists are a raucous bunch who breaks everything they can lay their hands on, especially after lots of alcohol and weed. Perhaps also due to the fact that marketing and management was outsourced to a 3rd party, which charges 25% on all revenue, that made it less worthwhile.

I have rated the 5 passive income streams, based on my own investment portfolio and experience, to compare how they rate against each other in terms of income potential, time factor, degree of passiveness and cashflow regularity (1 being least; 5 being most):

Hopefully this comparison gives a good snapshot on the return, time and effort on each of the 5 passive income showcased here so you can decide the right mix based on personal priority, preference and time commitment. 

With the advent of technology, there are many other ways to earn passive income such as affiliate marketing, dropshipping, develop online courses, write an e-book etc. However these require a lot more effort (not just during creation but also post-creation marketing and promotion), specialised knowledge or tools, the need to really stand out in crowded and competitive marketplaces to make meaningful income stream.

For me, income regularity reigns supreme as the cashflow enables me to plan and act more effectively. These are the 5 passive investments that are tried, tested and proven to generate regular income that has put me on a path to freedom and retirement.

“You become financially free when your passive income exceeds your expenses” 

~ T. Harv Eker

 

Passive is impressive,

Savvy Maverick

(Credit for main image: Red Charlie on Unsplash)

Disclaimer: The views expressed here are drawn from my own experience and do not constitute financial advise in any way whatsoever. Nothing published here constitutes an investment recommendation, nor should any data or content be relied upon for any investment activities. It is strongly recommended that independent and thorough research be undertaken before making any financial decisions, including consulting a qualified professional.