Growing Your Passive Income Streams
If you know me or have visited this site before, I'm sure have grown to realize that I am a supersized advocate for passive income. I believe that growing a diversified balance of income streams will set the foundation for financial independence more quickly than savings and traditional investing alone. The concept is not radical, but implementation and knowing where to begin in this path can pose a challenge. So that's exactly what this post is about. I will highlight some different methods of passive income investing in addition to the pros and cons, and possible barriers to entry for each product.
Luckily, we are in a great period for the passive income investor, as technology and financial services are blending together to make opportunities more readily available and transparent than ever before. There are some new players on the scene due to this marriage of new and old, which fit nicely into our first category of passive income investing.
Crowdfunding is a relatively new concept which is helping to democratize the investing landscape. It is a medium that brings direct investment opportunities (once primarily restricted to the ultra-wealthy) to nearly anyone with an internet connection.
But not all crowdfunding platforms are created equal. It seems there are are an endless array of options out there that allow you to help jump start someone's small business or artistic dream (you’ve likely heard of GoFundMe or Kickstarter). The problem is that most of these sites only offer small gifts of appreciation in return for your capital. While this can be heartwarming, we are here today to discuss real money back in your pocket. Where do you go and who do you trust to do just that? Luckily there are sites such as YieldTalk that do a nice job of presenting vast array of available options.
Filtering through these options, here are some of my favorite platforms (separated by category) that allow you to put your money towards a service or project while also paying you for that generosity.
Business / Startup Funding
MicroVentures: This platform allows you to be a venture capital investor from coziness of your recliner. Simply create a profile and start browsing an array of interesting business ideas in which you would like to help seed. All the detail needed for each business opportunity is provided online, so you don't have to do any heavy lifting. This platform is open to both accredited (someone who earns at least $200k/year or has a net worth of at least $1 million) and non-accredited investors; however, the opportunities for non-accredited investors can sometimes be limited. There is a low floor to entry since investors can get in with as little as $100.
Wunder Capital: This investment will pull at the heart strings of those who have a passion for environmental issues. As an investor, you can contribute money to help fund pre-vetted solar projects across the United States. Targeted returns for your capital are between 6 and 8.5% annually, over the course of 7-10 years. The minimum investment of $1,000 isn't a high hurdle, but they only have one fund currently open for accredited investors. Keep an eye out as this will likely evolve as we go forward.
Peer-to-peer lending is where everyday folks lend directly to each other, leaving the traditional banking system out of the fold. This allows for an open marketplace with lower transactional fees for borrowers and potentially higher returns for lenders.
The returns for an investor could expect to receive will vary based on the risk level of the loans you target. The two largest companies in this space presently are Lending Club and Prosper. Since I haven’t done much personal digging into the peer-to-peer space, I won’t comment on these two platforms individually. But a good comparison was conducted by Rob Berger over at Dough Roller. Both seem to have a fairly extensive underwriting process, so investors should feel they are receiving a quality analysis of their perspective loans in order to make an informed investment. Both also seem to have an excellent user interface and charge the same 1% annualized fee. Just note that the platforms are not open to investors in every state (presently not in PA for either, otherwise I likely would have tested them), so make sure to check to see if your state is open to investors before proceeding. Other than the state restrictions for some, most anyone can sign up to invest as the minimums are very low at $25.
Note: Keep in mind that these platforms have only been around post-2008. It is unknown how peer loans will perform during a major market correction, but historical evidence would suggest that they are susceptible to a high amount of risk. Personal loans are high yield in nature. If the high yield corporate bond space is any comparison, that space saw a decline of nearly 24% in 2008 (as measured by the iShares iBoxx High Yield Corporate Bond ETF, HYG). Personal loans could take a similar (if not worse) hit should another downturn happen.
AHP Servicing (American Homeowner Preservation Servicing): This is a rather unique investment opportunity, as the fund buys distressed mortgages from banks for cheap, then works to renegotiate terms with the homeowner to keep them in their home. The goal of AHP is to help families at risk stay in their homes and build stable communities. As an investor who supports this goal, AHP is targeting to yield you a 10% return before they take additional earnings. There are no investor fees, but one could expect their money to be tied up for up to 5 years. The fund is open to all (accredited and non-accredited) investors with a $100 minimum deposit.
Fundrise: Maybe the longest-standing platform in the real estate crowdfunding space, Fundrise allows nearly any investor (accredited and non-accredited) to quickly and easily access the private REIT (Real Estate Investment Trust) marketplace. They have an intuitive platform and 3 investment plans/funds available (Income, Balanced, Growth) which better aligns investors with their true financial objectives. Projected returns vary between 8.3-10.5% after the 1% management and advisory fee is deducted. The funds are structured for a 5-year time horizon and should be approached as such, but liquidity is available monthly after a 60-day waiting period from request (and potentially subject to a 3% redemption penalty).
Small Change: Small Change is also making it easy to invest in direct real estate developments, but with a more boutique touch. There is no large fund here. Each investment is a stand-alone project with a story behind it. This provides a level of connection that delivers a more meaningful experience for the end investor. Projects vary but are generally available to both accredited and non-accredited investors, with most seeking to yield between 8-12% throughout the term of the loan/project.
NOTE: As with any investment you make, please note that there is no guarantee on returns within these crowdfunding platforms. Each organization referenced above lists a target of what their investors could expect to receive; however, promises are not included. Approach each situation with the premise that you could potentially lose some, if not all, of your money.
Dividends are a stream of money paid to a company's shareholders out of the cash it earns from operations. As an investor, this is about as passive an income stream as you're going to find. One gets paid for simply buying and holding a stock which is simple and straightforward. But as with anything in life, when something is really easy to do or obtain, the reward isn't necessarily going to be highly lucrative. Dividends are no different. An investor should expect a well diversified dividend portfolio to pay them anywhere from 3-5% in return. Anything more and you are likely investing in high risk assets that will have a large amount of volatility. And volatility is a roller coaster ride in which most investors can't tolerate for long.
When investing in dividend paying securities, I recommend you educate yourself before making a purchase. Look for companies which have a solid track record of consistency and/or growth in their earnings. This can be measured by a ratio called Earnings Per Share (or EPS). Also, screen for companies that aren't paying out nearly all their earnings in the form of dividends. This means they aren't able to reinvest in and grow their business. You can measure this by looking at the Payout Ratio of a company. Both ratios can be found by using an online resource such as Morningstar, and looking under the "Key Ratios" of a company you search.
Direct ownership in cash flow positive real estate is one of my favorite passive income streams, but requires more time and due diligence from an investor than all the other passive income sources referenced here. Buying the right property is key to making a smart investment in real estate, so education on the topic before initiating a purchase is a necessity. In turn, the payoff for a good purchase can be very lucrative. Whereas other passive income sources generally yield between 3-8% of your cash investment, real estate can push you into double digit yields fairly quickly (in addition to the principal pay down of your loan, appreciation of the property, and tax benefits). This will certainly boost your odds of securing early financial independence!
If looking to get started in real estate, the folks at BiggerPockets have a ton of great information on their website and a tremendous following. Join their community, poke through the forums, and start listening to their podcast to help kickstart that education. Books such as Rich Dad Poor Dad have also influenced many a person down the path of real estate.
When analyzing potential investment property purchases, I recommend you stick to the 1% Rule to help you weed out those locations that might prove to be a drain on your wallet. This means that projected (gross) monthly rental income should be at least 1% of the total purchase price of a property (closing costs included). Of course, there are many other variables that will impact the profitability of a real estate investment, but utilizing the 1% Rule will help assist in your path towards purchase of only those properties that will be cash flow positive after all expenses (principal, interest, taxes, insurance, vacancies, maintenance, capital expenditures) are factored. Remember, we are focused on passive income here, not appreciation, which is another form of investing all-together. Check out my real estate resource page for a couple good providers of turnkey investment properties that I have personally vetted. They tend to have a nice selection of locations that fit this 1% Rule. Homeunion and Roofstock are larger-scale national turkey providers that have gained traction more recently. Although I can't speak to the quality of their product/processes, they also tend to have a healthy database of available properties meeting the 1% Rule.
Syndications / Partnerships
Investing through a syndicate is another way to gain exposure to the benefits of real estate passively. A syndication is a private investment structure (usually designed as a partnership) where a lead individual and/or entity will put together a deal to purchase a property (or properties), allowing other investors to join as limited partners; essentially buying a share of the deal. It operates like a crowdfunding investment, but is usually much more exclusive. As part of a syndicate, you will participate directly in the returns of the investment, but won't participate directly in managing the investment. Returns here can be lucrative, but this structure does add a layer of risk. Make sure to only invest with someone who has an established track record of solid performance. Groups like Western Wealth Capital have a good track record of performance, and doing right by both their partners and residents of their properties. This space is usually reserved solely for accredited investors while investment timelines normally range anywhere from 6 months to 7 years.
NOTE: I write about and track the performance of my own real estate investments in my blog, and will be digging into further educational items regarding real estate going forward. Make sure to sign up for my newsletter at the bottom on the page so you don't miss out.
To round things up, I am going to throw traditional retirement accounts into the passive income conversation. Certainly, if you're over the age of 59 1/2 and already retired, you can bank on steady withdrawals from these accounts to provide for your living expenses. That is exactly what these were designed to do. But something not known to all is that even early retirement enthusiasts can look to the money saved in their IRAs to supplement their living needs. And penalty free! This can be done through the Substantially Equal Periodic Payment (SEPP) program.
The SEPP program is allowed through IRS Rule 72(t), which permits for penalty-free withdraws from traditional IRA accounts, provided the owner takes at least 5 years worth of payments as calculated by one of 3 IRS-approved methods. Bankrate has a good online calculator if you are curious about finding how much you could receive (monthly or annually) for annuitizing your IRA account. All three calculations are listed on their site. The "reasonable interest rate" is any rate less than or equal to 120% of the Federal Mid-Term interest rate. You can find those listed rates here.
For those looking to achieve financial independence earlier in life (hopefully you all are!), taking advantage of the SEPP program will allow you to access your IRA funds while avoiding the 10% penalty you would otherwise face on withdrawals from those accounts before age 59 1/2. Score one for the good guys.
Are there other options for passive income investing that I’ve left out and you would like to reference? Please do share them below!