Money making money: why passive income is key to generating wealth
If you ask your average millionaire how they made their money, you’ll find that most build wealth over time. They don’t achieve wealth by pinching pennies or increasing salary alone, but rather, through alternate, passive streams of income.
Most have built multiple streams of income — the average reported number is seven — through which they gain retirement assets, investment capital, and income for regular expenses.
Passive income is one of the main mechanisms by which, as the saying goes, “The rich get richer.” While most of us have done at least some passive wealth-building, such as stashing money in an interest-bearing account, that isn’t how the wealthy do it. For better wealth management, you need better tools.
So how do you get your money working harder for you? Fortunately, passive income is no longer a tool exclusively for the top 1 percent. With the right knowledge and strategy, anyone can leverage their income and savings to begin building real wealth in the short term.
Today, we’ll take a look at passive income — why it works, and the best ways to leverage it in your portfolio. Read on to get acquainted with this powerful tool. We’ll give you an overview of the top passive methods of achieving high-performing returns on your investment portfolio, including the one we’re most excited about.
Why passive income is critical to wealth-building
There are only so many hours in the day, so making the best use of your available assets is critical. While the world takes on an ever-increasing amount of side hustles, there’s still a limit to the amount of work any one person can do.
This is where passive income shines. While you can only work so many hours, your money can work tirelessly for years. It doesn’t suffer burn-out, and never needs a vacation. It earns while you sleep. Passive investment vehicles do this without the need for hands-on management or time investment. While you make income, your investments multiply it.
Passive income also has several attractive benefits over other forms of investment:
Recession resistance. When you invest heavily in stocks, you are subject to the swings and adjustments of the market. Many passive wealth-building models work outside the mainstream markets and are therefore less susceptible to the impact of market forces. Passive income can provide a more stable route to returns, and help balance overall risk within your portfolio.
Tax benefits. Short- and long-term capital gains taxes can have a significant impact on your bottom line return. These taxes, which are incurred when you sell a stock or security, can range from 0 percent to as high as 37 percent. Passive income vehicles are not subject to the same tax laws, and in many cases may incur lower effective tax rates than stocks, bonds, and securities.
Make sure your “passive” income is really passive
Not all income opportunities are equal. Selecting the right income vehicle will be an important part of your investment rationale.
Here are a few key factors to consider when evaluating a potential income stream:
Time and Utility. Not all high-yield investments experience short-term returns; many passive income vehicles, such as venture capital funds, are longer-term investments. While they offer excellent ROI, if your goal is passive income, you’ll want to consider an opportunity with recurring cash flow and shorter return horizons.
Flexibility. Passive income relies on having access to returns on an ongoing basis. When evaluating an opportunity, consider the liquidity of your invested funds. Will you have access to the funds when you need them? What is the expected time to realize a return? Are there lockouts to consider? For instance, investing in a 401k can yield higher returns than a standard savings account; but the money isn’t liquid, and early withdrawals carry potential penalties and fees.
Expertise. When investing in an asset, acknowledge the level of expertise needed in order to safeguard your capital and see sufficient returns. Consider how much you know about the opportunity (for instance, the tenancy expertise and repair knowledge inherent in owning a rental property) and how much hiring the right support will cut into your bottom line. While monthly rent checks are technically passive, the energy and expertise involved in supporting tenants is anything but.
What are some of the most popular passive and semi-passive income options?
Passive income is the gold standard, but it’s important to choose the right form of passive income to meet your investment goals.
High-yield Savings/Money Market Accounts/CDs
High-yield accounts and CDs are the safest and most common interest-generating vehicles. They offer a quick, secure way to park a lump sum of money and gain interest. While average returns these days are minimal (under 1 percent), they do offer an alternative to non-interest accounts.
Two key points to consider with high-yield savings and CDs:
- Money market accounts are typically subject to account minimums in order to qualify for a special interest rate.
- CDs have a specific time for performance, with most CDs having a maturity period from one to five years. Early withdrawal from a CD incurs penalties to earned interest.
Renting out property is a popular method of achieving semi-passive or fully passive income. Rentals, whether residential or commercial, can provide a steady source of recurring income indefinitely. In addition, owners can benefit from the appreciation on their real assets.
Semi-passive rental income involves a hands-on approach: responding to issues, marketing units, qualifying renters, and caring for common area services like trash and snow removal. For those looking for fully passive income, a management company will take on these tasks for a management fee of 7 to 10 percent. The fully passive approach means you’ll have no hands-on time with your properties; however, you may spend time communicating with management and conducting administrative tasks for your business.
Real Estate Investment Trusts
Real estate investment trusts (REITs) are a popular method of gaining passive income from real estate properties. Whereas investing in individual rental properties is a semi-passive or active investment, investing in a REIT delivers returns without the need to manage properties, screen tenants, or conduct repairs. REITs are essentially management companies that operate income-generating properties, whether commercial or residential. In recent years, fractionalized investment platforms such as Fundrise and DiversyFund have come to market, allowing investors to invest with smaller initial deposits.
Investing in a REIT doesn’t come without its downsides however. REIT’s are typically taxed at a higher rate than dividends and often require a Schedule K-1, which can add complications come tax season.
Unlike growth stocks, dividend stocks reward investors through profit sharing. Investors receive cash payments at regular intervals. Although dividend stocks aren’t a guarantee (some do fail), they offer an alternative to growth stocks for those interested in a lower-risk position in the public markets. Dividend stocks can improve the diversity of your overall portfolio, as well as create a regular income source.
Ownership of franchised businesses is one of the favorite wealth-generating tools of the top 1 percent. High-net-worth individuals, athletes, and celebrities have been using franchise ownership to drive impressive profits for more than 40 years.
Franchise owners follow a marketing and administrative plan set out in their agreement, and use the power of replication, systems, and branding to ramp up profitable locations much faster than traditional brick-and-mortar stores. Franchising can be semi-passive (managed by the owner) or fully passive (managed by a management team for a fee).
While franchising can drive returns of over 150 percent, the high cost of entry has traditionally made franchising a passive income tool available only to the already wealthy.
The power of passive: Fractional franchising with FranShares
Fractionalized investment has become a popular method for average investors to take part in high-yield, passive income streams with a much lower barrier to entry. Avenues to invest in real estate (Fundrise, DiversyFund), wine (Vinovest), and stocks (Robinhood, Public) are opening for investors every day.
At FranShares, we want to bring the power of franchise ownership to every portfolio. Using a crowdfunding approach paired with professional management teams led by franchise industry experts, we’re creating a fractionalized platform that allows you to invest in a portfolio of well-known, fully vetted franchise opportunities for as little as $500.
If you’re ready to take part in this new approach to franchise ownership, join our wait-list and you’ll be the first to know when new funds open.