The goal for many people is to earn money on the side, while they go about their daily lives. For the most part, this is known as having a passive income and many have the goal of using this cash flow to achieve financial independence or what is commonly known as financial freedom.
“How do I invest for passive income?” is a common question among investors. They are mostly people who don’t want to be trading shares all day, or watching the markets, but would much prefer the “slow and steady” approach to investing.
To some this may sound dull but there’s nothing remotely trivial about long term conservative investing, and it’s even less trivial to look for passive income streams.
A passive income is effectively money coming into your bank account and requires no or at least very little effort from your part. However, as you’ll quickly discover, financial planning for a truly passive income is easier said than done.
Many sources of passive income are either just another job or not really worth it in terms of the returns you’ll likely make. Other passive investment options simply don’t provide a high enough return. While passive investment options are growing by the day, the ones that actually stack up are hard to find.
So what are some ways people can try and generate a passive income stream?
In years gone by, putting your hard-earned money in the bank was a great way to go about making some extra money.
However, in recent years, interest rates have been on a steady decline to where they currently sit. Unfortunately, putting your money in something like a term deposit, savings account or bank account is generally not going to make you any real money. After inflation, you’re probably losing ground.
Things might change in the coming decades, but for the foreseeable future, we should expect interest rates to be low and banks will not be too generous in handing over any interest.
One strong benefit of term deposits is that for deposits under $250,000 these funds are guaranteed by the Australian Government under the Financial Claims Scheme. This makes term deposits very very safe.
Investing in Bonds
The fixed interest market is a good place to go for passive income investments. The fixed income markets are actually bigger by value than the share market, and generally less volatile.
Government bonds are particularly expensive (and thus have low yields) and can be hard for retail investors to access but there are now bond funds being created to make it possible for everyday investors to earn a potentially reliable income stream.
Buying Dividend Stocks
A way to generate good cash is to invest in stocks that pay a healthy dividend yield. In fact, there are plenty of stocks that are offering yields of over 5%, which in the current interest rate environment is pretty healthy.
Dividend investing can be even more beneficial to investors if they come with franking credits, which mean the tax on that money has been paid (at the corporate tax rate) and that means you’re getting more money in your pocket.
The catch is when it comes to actually selecting the right dividend-paying stocks to invest in. Investing in the stock market is not an easy thing to do, which is why there is an entire industry focused on doing just that.
Remember, even if a stock is paying dividends, the share price of the stock can go up and down, representing capital gains or losses. Also, no company can guarantee dividends and can change or cut their dividends.
Investing in ETFs
A smart and effective way of generating a passive income is by investing in ETFs.
ETFs or exchange traded funds are a modern way to invest in the stock market without the need to try and pick individual companies while gaining the benefits of diversification. At eInvest we are focused on active ETFs, which are effectively funds that are managed by a professional portfolio manager.
Active ETFs employ a range of strategies that allow investors to achieve certain goals such as capital growth or regular income.
The eInvest Income Generator Fund (ASX: EIGA), is an active ETF with the goal of delivering investors regular monthly income.
The eInvest Income Generator Fund (ASX: EIGA), launched in May 2018, aims not only to provide a return of 5% per annum but also the additional benefit of franking credits which can add 2% to the return, resulting in a 7% total target return.
Investing in an active ETF like EIGA is very similar to buying dividend stocks, it just makes the process far easier and better diversified. It’s about as close as you can get to achieving a passive income.
Invest in Property
Property investing has long been a favourite in Australia although generally the returns from property come from capital gain, which can be large (particularly if you have held it for the last five years or more) but can vary more than you think depending on when you buy and sell.
The main challenge with property is that it is illiquid; meaning, it’s hard to sell quickly. It’s called a lumpy asset. There are also significant transaction costs, such as stamp duty and sales agents’ fees that will reduce your returns.
There’s also the issue with trying to find properties that offer high rental yields.
Apartments can have higher yields but come with higher costs from things like strata fees. Some people look to regional areas which come with issues of their own, particularly with rental properties.
It’s also worth noting that most investors use property managers to look after the property and find quality tenants and the costs can quickly eat into your profits. And that’s also not taking into account any loan repayments.
Commercial property can offer high yields and one of the big advantages is the tenant often pays all the costs. However, investing in commercial property is not for the faint-hearted, as vacancy periods can be hard to deal with and when compared with residential, commercial generally requires a higher amount of capital to obtain a loan.
Investing indirectly in property is also a popular way of trying to generate passive income streams. A property syndicate is a way in which investors get exposure to property without having to spend the time or the money researching endless opportunities.
A syndicate is put together by a licensed provider and then purchases a property (often commercial property). Investors are paid regular dividends, which are based on the income the property produces or the rent.
The downside of commercial syndicates is that they are generally only available to sophisticated investors and there are significant costs associated with the running of the fund as well as the same initial purchase costs (stamp duty) that are attached to normal residential property. In many cases, you’ll be lucky if 85% of your funds actually make it into the investment.
Property syndicates are risky.
Peer to Peer Lending
Peer to Peer Lending is a relatively new approach that investors can use to generate income streams. There are now online platforms that act as a middleman to help connect investors with businesses or entrepreneurs seeking money.
Many of these ventures are early-stage companies and may not be suited to those watching to generate passive income ideas, however, there is unlimited potential for would-be investors.
In recent years, Airbnb has been a new way for people to build passive income. In areas that are popular with tourists and travellers, it’s not uncommon to see many houses listed on Airbnb as short-term rentals.
Some people even go as far as renting out a spare room in a bid to make an extra income.
Airbnb is certainly a good way to earn income, but you still need to run it as a business, so it is not really a passive investment. You can hire a property manager to look after all the day-to-day details, but they charge around 20% for their time. That can really hurt your margins.
If you manage the property yourself, it will likely end up being a progressive passive income and not what a completely passive investor might be looking for.
Start an Online Business
Running an online business is a great way to earn a passive income, but to get the business to where it is passive is generally rather difficult to achieve.
There is no shortage of things you can do online, including creating a course, making YouTube videos and starting a YouTube channel, doing freelance work or selling products on eBay or Amazon.
But again, this is creating a side job and less of a passive income idea.
Why Active ETFs?
At eInvest, we like active ETFs. Our vision is to provide all Australians greater access to investment options suitable for them to grow their wealth and one strategy that we focus on is generating passive income consistently.
In fact, the eInvest Income Generator Fund (ASX: EIGA), aims to provide a return of 5 % per annum plus franking credits which can add 2% to the return.
As we can see from the other options of passive income, investing in an active ETF that can achieve those types of returns on an annual basis is a powerful tool.
Disclaimer: Please note that these are the views of Camilla Love, MD of eInvest, and is not financial advice. To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au