The average millionaire has 7 different streams of income. In my own quest for millions, I’ve spent much of the last year diversifying, testing out new earnings strategies, seeing what sticks and what flops. The gold standard of income streams is something I’ve yet to figure out though – passive income. Passive income is income you earn on a regular basis with minimal maintenance efforts. You put in the work up front, then income largely comes in on its own. My book, for example, is a source of passive income (however minimal).
Today’s guest poster, Joseph Hogue, is a professional investment advisor who generates passive income through investing. Today, he’s on the blog to share some of his best investments for passive income.
Passive income investing strategies abound, but reality seldom lives up to the hype. Avoid the biggest pitfalls with these two best investments for passive income.
As an investment analyst of nearly a decade for venture capital firms and individual investors, I have seen my share of passive income strategies. If the term doesn’t seem familiar, think of every email or website you’ve seen promising huge monthly income from an investment with little or no effort.
Yep, that’s passive income investing. The idea that you can invest in something and collect a regular check from the cash flows without having to do to continuous analysis or management.
You’ve hopefully seen through the scams promising instant six-figure incomes at the click of a mouse, but there is some truth to the notion of investing for passive income. Investing for income is a favorite for many because it can provide a stream of cash for living expenses while still offering the potential for upside in price appreciation.
Among all the investments and strategies, two stand out as my favorite for passive income.
They aren’t making any more of this passive income investment.
Ever since Will Rogers called real estate the best investment in the world back in 1930, investors have jumped at any new way to make money off of land and its use.
Renting residential homes and apartments continues to be a popular passive income strategy on the web and with investors. The idea of buying an asset with less than 20% down and having renters pay off the mortgage is a persuasive argument.
I have renovated and rented houses since 2002, with as many as six houses heading into 2006, and am still pretty active in real estate investing. Real estate rentals can be a good source of cash flow once you start paying down mortgages but it becomes very clear, very quickly that it is far from a source of passive income.
For truly passive income in real estate, I now prefer shares of real estate investment trusts (REITs). These are stock shares of companies that own real estate investments, mostly commercial properties, in the United States and even globally.
The special type of company was created in 1960 when Congress passed a law that REITs would not have to pay corporate income tax if they passed at least 90% of annual income on to shareholders as dividends. This created a huge tax advantage for REITs as real estate holding companies and even non-real estate related companies like McDonald’s have considered forming a REIT to hold their land ownership.
Investors win because the mandate means higher cash payouts for REITs compared to most traditional stocks. The Vanguard REIT ETF (NYSE: VNQ) pays a dividend yield of 3.9% annually, nearly double the yield paid by companies in the S&P 500.
Unlike real estate rentals, your investment in REITs does not require around-the-clock management to fix broken water pipes and secure rental permits. Buying a few funds that hold shares of REITs can diversify your investment across different property types and geographically.
The passive income investment that should be part of everyone’s portfolio…but isn’t.
In my experience and research into passive income strategies, one investment stands out as easily the most passive – bonds.
Bonds are an ownership of the loans taken out by companies and governments. The investment is also called fixed-income because investors receive fixed interest payments, usually twice a year, until the loan expires. Once the loan matures, investors receive the principal amount back and can take the money or reinvest in other bonds.
Bonds easily hold the highest passive income potential of the investments I’ve seen because they require almost no time to manage the investments and start cash flowing immediately. Unlike stocks, in which investors constantly feel the need to buy and sell, it’s more common to hold bond investments to maturity. While the underlying price of your bond may increase or decrease on a daily basis, you are guaranteed a fixed return as long as you hold it to maturity and the company doesn’t default on its loan.
Bonds can be bought with maturities of a year all the way up to 99-years and from some of the largest companies and governments in the world. Buying shorter-term bonds means you get your money back sooner while buying longer-term bonds will get you a higher interest rate paid on the loan. The best strategy when buying bonds is called laddering, where you buy bonds of different maturities so you have a good mix of short-term and long-term investments.
Despite the great passive income potential in bonds, most investors neglect the opportunity.
The American Association of Individual Investors (AAII) surveys investors monthly and found recently that bond holdings were just 15% of the average investor portfolio. Since older investors typically hold much more of their portfolio in bonds, this average means that many younger investors may be holding no bonds at all.
Bonds aren’t just a great passive income investment; they’re also a critical part of a well-rounded investment plan. When stocks crashed more than 50% over the year to March 2009, bonds continued to pay their fixed rate of return. Investing in bonds of financially-sound and highly-rated companies will help ensure that the loans are paid in full and you get your constant stream of income.
Avoiding the hype in passive income strategies doesn’t mean you have to shun the investments entirely. Invest in yourself and learn the truth behind passive income investments to take advantage of a great opportunity in cash flow.
Joseph Hogue, CFA is an investment analyst and author of The Passive Income Myth: How to Create a Stream of Income from Real Estate, Blogging, Stocks and Bonds. Join the community on PeerFinance101 for more tips on investing, managing debt and reaching your financial goals.