Passive income options in the 21st century
What is passive income?
Passive income consists of earnings made on regular bases without active effort. This income rests on the notion that people are good at making money, but money is very, very good at making money. Strategies for passive income have existed for millennia, as far back as Roman landlords if not further. Today there are numerous methods for generating such income, many taking advantage of developments in technology. Five such strategies are listed here, all of which can be availed of without much in the way of barriers to entry. These strategies have differing risk/reward ratios and associated benefits and disadvantages, which this article will attempt to present. Diversification between different passive income avenues presents a way to hedge against risk and also to deliver returns at varying intervals.
The passive income people will be most familiar with are savings accounts and certificates of deposit (CDs). These generate interest paid at the end of a fixed term with CDs, or usually on a yearly basis in standard savings accounts. These accounts are as close to risk-free as possible, but the return on investment is almost always very low. For CDs interest trends around 1.5%, with standard savings accounts yielding far lower. Given that the inflation rate in the US (and most developed countries) is north of 2% per year, this is not enough to offset inflation so the effective value of the investment actually decreases over time. Compound interest at 1% is better than nothing, but it is no strategy for long term passive income.
Investing in dividend stocks is a tried and tested method of generating passive income. Holding shares in dividend paying companies will grant a percentage of profits, which are distributed back in proportion to the number of shares held. This generally happens on a quarterly basis, even though the dividend yield is often expressed in annual terms. Factors to consider here of course include the company’s valuation, the payout ratio (how much profit will be distributed — 50%, for example) and the company’s recent performance.
These are online investment management platforms which provide opportunities based on the user’s choice of risk strategy using computational models, algorithms and portfolio rebalancing to maximise returns. They typically invest in ETFs and index funds, with prominent examples including Betterment and Personal Capital. These services charge fees much lower than human financial advisors, and they require minimal input on the user’s part when it comes to portfolio management. Reviews for these services have been highly positive, but it should be noted that they have not yet been tested in a real bear market, at least in the US, as they emerged after the financial crisis and during the recovery trend.
Cryptoassets We published an article last week detailing the many strategies for earning passive income in cryptoassets, including some example returns-on-investment which dwarf most other strategies detailed here. To summarise, however, cryptoassets can generate passive income by mining, staking, delegating, or holding a ‘dividend coin’. It must be considered that the risk in these assets is also higher, due to their volatile nature, the unclear regulatory environment and a market yet in its infancy.
Passive income derived from property rental can be extremely lucrative, especially in big cities where 10% increases in rent per year are not uncommon. It goes without saying that property prices in general chart the same course, so purchasing property also becomes more prohibitive year on year. An alternative to purchasing property is to join a crowdfunded real estate investment trust (REIT) which will pool and leverage investments into income-producing real estate, including commercial, housing and mortgages. The stake is generally liquid (easily withdrawn), and at least 90% of income is distributed back to shareholders as dividends.
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