In order to reach early financial independence, you will either need a ton of cash, or enough passive income coming in each month to cover your expenses. If you weren’t fortunate enough to start your own thriving business, or join a start up company pre-IPO, chances are pretty good that you’ve also decided to pursue the passive income route.
There are many investment vehicles out there that you can use to help generate passive income. However, no two types will perform the same; some will be more passive than others.
Since I’ve been investing long enough to have exposure to many different kinds of investments, I thought it might be useful to classify them, in regards to passivity.
1/10 (80 hours per month)
2/10 (60 hours per month)
3/10 (40 hours per month)
4/10 (20 hours per month)
5/10 (10 hours per month)
6/10 (5 hours per month)
7/10 (2.5 hours per month)
8/10 (1 hours per month)
9/10 (0.5 hours per month)
10/10 (less than 0.5 hours per month)
Savings Account and CDs
The simplest form of passive investing is through the use of a conventional savings account or CD. My own personal savings account returns a paltry 0.05% interest. I’ve collected less than $1.00 year to date. CDs aren’t much better, and rates today start at about 1.0%. If your goal is to reach early financial independence, you will need to find a better investment alternative that returns a higher yield. Otherwise, you’ll probably never get there moving at a snail’s pace…
My Passivity Rating: 10/10
My own experience: I keep an emergency fund in a standard savings account. Nothing special going on here. I might check up on the account once every few months or so, spending less than five minutes each time. Also, I don’t even bother looking at the “passive income” it generates. When it comes to early FI, my savings account doesn’t factor into the mix at all. I don’t currently have a CD account active.
Index Fund Investing
Many investors like to invest in index funds because they want to be as hands off as possible. As many have also learned in the world of stock investing, sometimes it pays (literally) to be an average performer. You can simply track an index as well known as the S&P 500, and by investing in low expense ratio index funds, you’ll still generate returns that’ll beat 9/10 actively managed funds out there.
Pretty sweet! When it comes to index funds, there’s almost no other form of investment that’s more passive, and can still generate such high returns. Index funds easily put the returns offered by conventional checking accounts and CDs to shame.
What’s the catch? Although index funds are wonderfully simple and passive, the income they generate can still leave a lot to be desired. For anyone on the journey to early financial independence, we already know that passive income is the name of the game. Thus, using the index fund approach may take someone awhile longer than if they were to use another alternative.
My Passivity Rating: 9/10
My own experience: For myself, I invest in index funds for my 401k and Roth IRA, but I don’t depend on them for funding my early FI income stream. I am planning on leaving these accounts alone until I am able to access them without penalty at 59 1/2. Yes, there are ways to get the money out early without having to pay penalties, but I don’t foresee the need to have to do so. As long as the early FI income streams are performing, I’ll simply keep the retirement accounts in place as a backup, or safety net. I spend about 30 minutes each month looking through the accounts and going over the transactions (dividend re-investments).
Dividend Growth Investing
While most major indexes won’t yield anything greater than say 2%, an investor can utilize a strategy known as dividend growth investing (DGI) to custom-build their own portfolio to enhance the yield. It isn’t uncommon for a dividend growth investor to start building their portfolio with an initial yield between 3% and 4%. Due to the nature of dividend growth, the yield on cost (YOC) gained over the years (due to consistent dividend raises) will only serve to enhance the total return of the portfolio. In other words, dividend growth investing is a powerful investment vehicle that can be used by an investor to help accelerate the cash flow generated by their portfolio. If done right, the numbers of years needed to reach early FI can be rapidly shaved off, when compared to most other investment vehicles. In fact, a lot of fellow bloggers and readers are using exactly the dividend growth investing route to get to early FI.
My Passivity Rating: 4/10
My own experience: Again, there’s a catch. Dividend growth investing can return a higher yield than index funds, but it can also be far less passive. Since you are in full control, there is no one else but yourself to help you manage the funds in your portfolio. This isn’t necessarily a bad thing, as you have the freedom to handcraft the exact portfolio you desire. You get to set how many stocks you want to own and what your asset allocation is across different sectors/industries.
Although you probably won’t need to tune in to every earnings report for each company you own, you’ll probably still want to monitor performance on a semi-regular basis. Even if you do invest in stable, large-cap blue chips, it isn’t unheard of for even premiere companies to announce dividend cuts (e.g. General Electric (GE) in 2009).
The biggest fear a dividend investor has is if the underlying stock they own either freezes, or cuts the dividend. I faced this very problem myself not too long ago when Exelon Corporation (EXC) announced a massive dividend cut of 41%.
Note: There is definitely an easier way to make dividend growth investing more passive — invest in only the “best-of-the-best” blue chip dividend aristocrats (PG, KO, MCD, PEP, JNJ, etc.). If you were to do that, the Passivity Rating could easily jump back up to 8/10 or even 9/10. The Passivity Rating of 4/10 only describes my own personal experience building a custom dividend portfolio.
Before liquidating my dividend portfolio to fund the purchase of Rental Property #2, I owned a portfolio comprised of 24 different companies. I probably spent about 20 hours/month (4/10 Passivity Rating) buying, selling, and monitoring my positions. I allocated even more time towards research (e.g. reading Seeking Alpha articles), but that was more for fun rather than out of necessity. If I were to include the research time spent, the total time spent each month would jump to 40 hours (3/10 Passivity Rating).
Portfolio Early 2013:
Turnkey/PM Real Estate Investing
I own three out-of-state turnkey properties that are managed by a local property management (PM) company. When buying a turnkey investment, the seller will always advertise the purchase as being as “hands off as possible”. Part of the allure for purchasing turnkey is that the income your investment generates is supposed to be completely 100% passive. The other (primary) reason for buying turnkey is for the higher cash flow return; if you select the right market, it isn’t unheard of to find cash-on-cash returns yielding over 10%. With rental properties, nothing is ever guaranteed though, so there will always be risks involved. However, if things work out as planned, you’ll probably end up reaching early FI sooner than anticipated.
My Passivity Rating: 5/10
My own experience: It hasn’t been a full year yet, but I’m finding the turnkey sales pitch to be surprisingly more accurate than not. I honestly didn’t know what to expect when I first started, but I’m learning first hand that the PM really does handle all the day-to-day operations. From tenant screening, to maintenance repair items, to rent collection from the tenants, the PM handles it all. In fact, sometimes I think they keep me too much out of the loop, so I always have to remember to send weekly e-mails asking for status updates. I do my best not to micro-manage (nobody likes that), but you do owe it to yourself to ask a lot of questions. It’s the only way you’ll learn how the process really works… and if you want more control (voice) over certain decisions (e.g. tenant approval process), you’ll have to let the PM know. Otherwise, they’ll just assume the responsibility and do everything themselves…
Granted, my low stress/headache experience might only be this way for now because I’m only on Year 1. As I’ve been warned many times before, you won’t really know for certain how things will be until you get to Year 2 or Year 3. That’s when you have to observe more closely, and watch to see if the wheels start to fall off!
But so far, so good. Right now, I’m probably spending about 10 hours/month total for all three properties. Most of my time is spent writing e-mails or going over owner statements, maintenance requests. And going to the bank to deposit rent checks (not all turnkey companies provide direct deposit/ACH service).
Here’s what a typical owner statement looks like (Chicago; March 2014):
Self-Managed Real Estate Investing
In addition to three turnkey properties, I also own and self-manage two local Bay Area properties. I won the first property in 2012 and the second one in early 2013. Even before I got started with landlording, I had this strong impression that there would be a lot of work involved. Since housing prices were so affordable when I bought, I figured the long-term rewards would be worth the effort. It hasn’t even been two years and my decision to buy is already looking like it was the right one to make. Housing prices have continued to surge, and the appreciation so far has been spectacular. These two rental properties are the best investment decisions I’ve ever made in my life, so far.
My Passivity Rating: 6/10
My own experience: My two self-managed rentals have been a tremendous experience so far. The Passivity Rating of 6/10 is not a typo. I’m certain this won’t always be the case, and it seldom is for actively managed investment properties, but I’ve been so fortunate to land some amazing (and self-sufficient) tenants. I believe part of that has to do with buying in the right neighborhoods and selecting high caliber tenants (high income professionals). Most of the work I spend on these properties is for periodic inspections, and phone calls/texts with the tenants.
So, although the cash flow numbers aren’t the greatest, there are definitely other benefits for paying more for quality. Right now, my real estate portfolio has a blend or properties — some that cater to low income and others that are more suited for high income individuals. Based off of my own local experience, I believe that my future purchases will again steer more towards higher quality tenants. There is a place in the portfolio for high cash flow properties, but I believe that the core foundation should be built on quality.
I’m trying to get to early financial independence as soon as possible. In the process, I have used many different investment vehicles, and I’m learning through experience which ones are most suitable for my own journey. However, lost in any cash flow, or yield analysis is the Passivity Rating of each investment. The above report was generated based off of my own individual experience, but I’m sure it will vary for each individual investor.
Note: I did not include any peer-to-peer (p2p) reports, as I have no experience using Lending Club, Prosper, or any other p2p networks. I am sure those are great investment alternatives, though, as I have heard great feedback from other investors. Again, there are many vehicles you can use to help take you to early FI…
What investments are you currently utilizing on your own journey to FI? What do you find most passive? Did things turn out the way you expected them to?