Passive income investments, provide an income without continuous input from the investor. A large enough passive income portfolio can replace your monthly paycheck and has the power to give you complete financial independence.
There are two ways to make a passive income. The first is through investments that provide multiple streams of passive income. The second is investments which go up in value and then can be sold in parts to create an artificial stream of revenue.
List of Passive income investments
Landlording – Real Estate
Real estate crowdfunding
Term Deposit accounts / CD ladders
Art and Collectibles
Agriculture & Farmland
Renewable Energy Investments
Loan payments are the opposite of a passive income investment, in fact when you borrow funds for consumption (rather than for investment) you are the subject of someone else’s passive income. Typically a bank or credit card company are receiving a regular payment from yourself. Paying off your non-productive debt or reducing it is important when this debt has a high-interest rate. Finding a better loan provider or merging all your loans with one provider is another option.
Learn how you can use the high-interest rate method or the snowball method to reduce your debt.
Being a landlord is a hassle, but has the benefits of financial leverage. A landlord can finance a passive income asset only with a 25% down payment of the capital needed. There are many variations on this theme. Significant economies of scale can be achieved when buying a block of apartments. A landlord can opt to have a property management company which shields him from the day to day hassle of managing any issues. There is also the opportunity to invest short term vacation rentals or city apartments via Airbnb.
Significant geographical arbitrage can be achieved when buying property as the yield rates and tax rates vary significantly from country to country.
There are passive income investment portfolios composed entirely of directly owned property.
Real Estate Investment Risks:
- Lack of (good) tenants
- Property regulations
- Non Paying Tenants
- Crash Property Market
- Costs that rise faster than the rent
- Unexpected costs
- Unable to finance the project
REIT (Real estate investment trust) are companies which need to distribute more than 90% of their income as dividends. There are many variations on REITs; some focus on hospitals, single-family homes and shopping malls. They manage the properties from A to Z. If all goes well the investors get a dividend. REITs provide a no-hassle system for owning property. There is a premium to pay on REIT assets because of the liquidity of the assets. VNQ is an easy way to invest in real estate. Learn more about What Are REITs?
- Inefficient Management
- High Costs
- Too high debt for the RIET
- Not making any profits and not paying any dividends
Similar to REITs real estate crowdfunding platforms facilitate the investment in properties. There are three main variations
- Investing in Buy to Let property
- Investing in Flips (buy low sell the high property)
- Investing in property-backed crowd-funded mortgages
The big advantages with these platforms are the ease with which to diversify across geographies and property types. The main difference between REITs and property crowdfunding is that, in property crowdfunding, the investments are done on a per property basis and in REITS the management make all purchasing decisions. Learn more about the closure of RealtyShares.
Real estate crowdfunding risks:
- High management costs (SPV per house) or risks concentrated on controlling entity
- Unsustainable governance model (Property Moose link)
- Returns are much lower than initially advertised
- Lack of liquidity when selling individual properties
- Concentrated risk and lack of diversification
- Incorrect unreliable property price estimates
P2p lending is the process of lending between people and business. A central entity which acts as a clearinghouse for these loans. Investing in p2p starts from under $100 and is usually available to any kind of investors.
There are many different forms of p2p lending. Some are secured with an asset such as a house, a car, or gold jewellery other p2p loans are unsecured. Some platforms offer to buy back guarantees, meaning they will buy back the loan and interest in case of non-payment for more than 90 days.
P2p lending risks:
- Unsustainable money back guarantees
- Incorrect LTV ratios due to a market crash or incorrect initial valuations of asset backing prices
- The default of the platform
- Exposure of investors to lawsuits by borrowers
- The 13 risks of p2p lending
Term deposit account are saving accounts which are locked for a certain period of time. The longer the time lock the higher the yield. This is a passive income investment because it gives out the internet. A CD ladder is created by investing in several time period CDs to obtain your ideal cash flow and to have the biggest compound interest possible. Learn more about: Term deposit accounts.
- Opportunity cost
- Any amounts not covered by governments insurance
- Low-interest rates
A bond is a debt obligation between a borrower and a lender. This debt obligation is composed of the amount lent, the yield, the passive income. Bonds are also called fixed income securities. Bonds earn interest because of the risk of default involved in lending money. Default occurs when the borrower cannot pay back the lender. Bonds start trading at their face value, however, these can go up and down according to the risk of default by the lender. The interest is what makes Bonds a passive income investment.
There are two main types of bonds, Government Bonds and Corporate Bonds. Generally the shorter the term of the bond the lower the interest rate, this pays the lender the cost of not having access to the funds for a period of time. The interest rate of a bond goes higher the higher the risk. Short term US Government treasuries are very low risk but Venezuelan bonds (as of Jan 2019) are very high risk.
Inflation is the erosion of the purchasing power of money, and inflation has been a standard phenomenon throughout most economic history. This means that the lender will lend funds worth so much purchasing power to the borrower, but the borrower will back less in purchasing power terms. This is another factor why a lender needs to pay interest. Treasury Inflation-Protected Securities (TIPS) are a form of US Government bond which pays lower interest but on the other hand the capital increases with inflation.
It is possible to invest in funds which invest in a diverse collection of bonds, there are bond funds to suit all needs some focused on Government debt others on corporate debt and everything in between. Bonds are probably the oldest form of passive income investments.
- Raising interest rates / Deflation
- The price of the bond / Downgrades
- The default of borrower / Credit Risk
- Liquidity risk / Market Demand
There are two types of index funds which can generate passive income. The first is funds which aim for capital growth but do not release any dividends. Here the investor needs to sell part of his shares to generate the passive income. In this case, a balance needs to be found on how much is taken from the nest egg vs how much is kept. The second way to own a passive income investment is through index funds which hold dividend stocks. Learn how to build a passive income portfolio with ETFs in five easy steps!
Index Fund Risks:
- Market Crash
Index fund examples:
Companies are owned by the stockholders. When a stockholder owns all the shares then she owns all the company, but stockholders can own less than 100%. They can own 10%, 5%, 1% or even 0.0001% of shares. The fraction of shares they own determines the fraction of ownership they have for the company. Ownership of companies determines the claim on any dividends paid out to stockholders. Dividend stocks are the king of passive income investments, as they provide with exposure to business making the economy work. Learn more about the pros and cons of passive income from dividend growth stocks.
The passive income from these investments depends on the profits these companies make. There are also index funds which can own a number of these funds. Dividends can be reinvested other passive income investments, this gives them the power of compound passive income. How to find dividend growth stocks for passive income, is the key to a long term sustainable portfolio.
In a dividend stock, the two most important factors are the payout ratio and dividend growth. The payout ratio shows what percentage of profits are being paid out as dividends. If companies keep their profits and do not distribute any dividends, then they do not generate any passive income. The dividend growth ratio shows how the dividends have grown over time.
Dividend stock risks:
- Market Crash
- Companies expand in other markets with disastrous consequences
- No dividend or reduced dividend growth
- Currency Risk
Dividend Stock examples:
A Robo advisor creates a personalized investment plan based on your financial situation, risk appetite and age. It can combine a mix of bonds, stocks and ETFs to diversify your investments.
Fees, historically performance and the incentives of the robo advisor are three important things to consider. For example is the robo advisor paid a commission on every trade, then wouldn’t it be more profitable for the robo advisors to diversify more often.
Robo Advisor can be instructed to invest in dividend stocks and bonds, investments that directly generate a passive income. Otherwise, a robo advisor can be set to invest in a diversified portfolio of growth stocks, if there is capital growth a percentage can be sold off as yield.
Robo Advisor risks:
- Algorithm failure
- Opportunity cost: Index funds
Robo Advisor Examples:
- Betterment: With no minimum investments and fees starting from 0.25%
- Bloom: Manage your 401k with this alternative Robo Advisor.
An annuity is a private social security contract. The structure is simple, an investor buys an annuity then pays a monthly fee, on his retirement date he starts getting a monthly payment back from the annuity. Learn more about Investing in Annuities, Fixed Term Annuities
Risks of Annuities
- Purchasing power, one is never sure to get back the same purchasing power that one has put in.
- The payback from the annuity could be tied to the annuitant is alive.
- The insurance company could fail
There is an opportunity to make a passive income through startups by flipping them, buying low and selling high. Keep in mind that only about 1 in 10 startups survives in the medium term and even less in the long run. This kind of passive income investment is quite risky. Today there are a number of options to invest in startups for both accredited and non-accredited investors.
Startup investment risks:
- Founder inexperience
- Lack of funding
Startup Investing Examples:
There are five main categories for passive income opportunities (and potential failures) when it comes to passive income investments.
The main issue with crypto passive income is the volatility of the underlying capital. Crypto passive income should not be measured in the cryptocurrency units but in purchasing power. Therein lies the power or failure of a crypto passive income investment. The investors have the choice to ignore this and choose to judge the passive income in the currency of the investment. The logic to this is that the crypto can either maintain or increase it’s purchasing power in the future.
Crypto investment risks:
- Bear Markets
- Theft of tokens
- Arbitrary changes to passive income conditions.
Crypto passive investment examples:
Holding shares or tokens that represent fractional ownership of art can also create a passive income. For the tokens to rise in the price of the art held need to rise in price more than the inflation. The shares representing the difference between the price bought and the yearly inflation in comparison to the current price represents the passive income earned.
There are alternative art platforms, such as Crypto Kitties which can generate a passive income through capital appreciation. Other platforms such as PixEos will allow artists to manage the rights of their work through Non-fungible tokens which represent the ownership of individual art pieces.
Art Investment Risks:
- Subjective value
Art Investing Examples:
Agriculture is the ultimate passive income asset, if done right it can enhance our environment and be the create multi-generational passive income investments. There are essentially three ways to use agriculture as a passive income investment.
- DIY – Buy the land, plant the trees, perennials or annuals. Enjoy the benefits yourself or sell them. Such an activity can be partially passive with mature trees, but less so with plants that need constant attention
- Buy Stocks of companies which are involved in agriculture, either directly or indirectly.
- Alternative agri investments. These are unregulated investments offering exposure to agricultural crops either directly. The problem with such investments is the lack of regulatory oversight compared to public companies. It’s all about risk and reward. There have been many investors who lost their funds in agri investments schemes which turned out to be outright schemes or otherwise. For example (Gregg Fryett and Agro Investment Plc)
Agri investment risks:
- Default / Liquidation
- Law / Regulation / Controlled markets
- Competition / Profitability
- Drought / Pests / Climate Change
- Transparency / Cost inflation
Examples of Alternative Agri investments:
Examples of Stock-based Agri investments:
Similar to agriculture solar energy has a lot of potential for passive income, similar to the agriculture passive income investments there are three categories
- DIY – Install solar power on your land or roof. Use the electricity or sell it to the grid.
- Buy Stocks of solar companies, operators of hydro dams or solar tech companies. There are two main categories, the producers of renewable electricity tech and infrastructure and the utilities operating renewable energy sources such as geothermal or hydro dams.
- Invest in crypto tokens of projects which are involved in the crypto space.
Renewable energy investment risks:
- More efficient technologies to create electricity
- Drop in electricity demand
- Cheaper alternatives
- Reduction of subsidies for the sales of renewable electricity
Examples of Renewable energy companies:
- Brookfield Renewable
- Nextera energy partners
- Pattern Energy
- Restart Energy
- The Sun Exchange
- Power Ledger
- Tesla Solar Roof
- Wunder Capital
Having an overview of all the passive income investments is important to understand how each different asset class has risks and rewards. Diversification among different asset classes exposes you to different risks and diversification of benefits. Passive income with the objective of financial independence is a longer-term project and requires the investor to have a long term vision about their portfolio.
The risks mentioned are examples, they do not include the full array of risks possible.