- Invest in properties that provide rental yield, hence an income for life with only some effort in management.
- You can start annuities by putting an upfront investment to avail a fixed amount of income for a period of time.
- If one has excess cash, one can utilize P2P lending platforms to lend to people at a certain interest rate, and get paid back the principal and interest over time.
- Create a bond ladder with bonds of staggered maturities, thereby maintaining a fixed income for a long period of time, as well as reducing reinvestment risk.
- Buy a set of stocks that pay dividends to create passive income, and mitigate risks by keeping the portfolio well-diversified and checking credit ratings of companies.
COVID-19 has not only been challenging from a health perspective. One of the key issues that has emerged over the past year is job security as numerous businesses struggle to stay afloat. This unprecedented event has brought to the forefront the importance of having multiple streams of income as it can help you carry on with life’s most basic expenses should you voluntarily or involuntarily end up taking time off work.
Until very recently, having a life where we are not constantly worried about the next paycheck was no less than a distant dream. However, the rise of the gig economy that offers more flexibility in career options, combined with the awareness of alternative sources of income, is slowly getting us closer to that dream. Building a source of passive income is no longer as challenging and all of us must strive to build at least one additional source of income that does not require perpetual active involvement. Not only will it help alleviate some stress of managing your expenses, but if built substantially over time, it may also enable you to achieve financial independence.
What is Passive Income?
Passive income is the money that you earn while not being required to do much “active” work in order to continue earning that income. But what’s required is that you put an upfront investment in terms of time or capital, or both. Thereafter, with some additional work along the way, you should be able to maintain that income for a long time.
As compared to active income, where the money you make is directly proportional to the man hours you put in, passive income gives you much more flexibility and freedom in terms of how you spend your time while continuing to earn. You could literally be making money while you sleep.
How can we build Passive Income?
We have come across multiple posts about building web content that earn six figures ad revenue or publishing a book that can earn you royalties for life. With the skills and effort required to get those up and running, it’s a classic case of easier said than done. The good news is, that is not the only way of building passive income. With good financial planning, you can leverage several financial instruments and other assets to get an alternative source of passive income flow. Let’s explore some of the options you can look at.
1. Real Estate
Real estate is one of the most well-known investments. The idea is to invest in properties that provide rental yield, hence ensuring an income for life with only some effort in management. However, be mindful that the property you are purchasing gives sufficient rental yield to make back the upfront cost and mortgage interest cost in the long run. If the upfront capital is not within your budget, you can invest in REITs, which eliminate the hassle of managing properties, and can be started with a small initial amount.
One of the most secure ways of having passive income is investing in annuities. These are essentially products that provide a fixed amount of income for a period of time once you make an upfront investment. The amount and period of annuity depends on the size of initial investment. Do note that these products are fixed income instruments and are subject to inflation risk over the long term, so it’s always better to opt for a step-up annuity plan where the regular cash income increases by a specified percentage over time. Another factor to keep in mind is that these products come at high fees, so they are more suitable for investors with very low risk tolerance as they may be more willing to pay higher charges for a guaranteed returns product.
3. P2P lending
Peer-to-peer lending has become increasingly popular as a source of immediate, short-term borrowing. If one has excess cash, one can utilise this avenue to lend to people at a certain interest rate, and get paid back the principal and interest over time. The interest you get is typically better than fixed deposits and liquid funds, making this an attractive option. As the lender, you must do your due diligence when you choose the P2P lending platform, as well as the borrowers. Go with a reputable platform and borrowers with a good track record. Spread out among a number of borrowers to mitigate your risks.
4. Bond Ladder
The fact that bonds pay a fixed interest till maturity makes them a perfect instrument to build a source of passive income. Having a series of bonds with different maturity dates can create a bond ladder. The staggered maturities help to reduce reinvestment risks i.e. when one ends up investing the maturity amount from one bond into the another one that pays lower interests. As you continue to receive passive income by collecting interest payments, you can use the maturity payout of the bonds to invest in another set of bonds for the future. You must know that government bonds (issued by governments) do not have credit risk while corporate bonds (issued by companies) with higher rates of interest may have a risk of default. So, diversify well and make sure to check the credit rating of the bond issuing institution or corporate. If it feels like a lot of work, you can set up your ladder using bond ETFs, which provide diversified funds of different bonds.
5. Dividend paying stocks
Although, involving its own set of risks, one of the most tried and tested ways to earn passive income is to buy a set of stocks that pay dividends. Few things to ensure will be that your portfolio is well-diversified and that the companies’ credit ratings are good so that they don’t default on their dividend paying obligations. While investing in stocks may seem to be a time-consuming task, you can also leverage robo-advisors to automatically invest in various instruments suiting your needs and risk-profile. All you need to do is to provide inputs, choose the right plan, and set up recommended investment strategies for long-term investing. Then you can sleep and let your money work for you.
The benefits of passive income range from providing additional financial support to helping you achieve complete financial independence. As different streams of passive income require different sizes of investment, risk and return appetite as well as time commitment, choose wisely based on your requirements and capabilities. Decide on an objective – is it to earn extra cash for a certain period, or are you looking to quit your full-time 9-5 job?
At Cashvisory, we will be coming up with tools to help organize every aspect of your finances. Whether it is to plan the financial commitments to be handled by your passive income, or to calculate how your extra income can help you reach your goals faster – you can do all of it in one single platform.