Passive Income – Why I’m Sitting on the Sidelines

When it comes to early financial independence, most everyone who starts on the journey wants to focus on passive income/cash flow. It is understandable why too — When you receive a periodic payment/distribution of income it is psychologically rewarding (you feel all warm and fuzzy inside). Although it is never the case, it essentially feels like you are earning “free” money. And that is precisely the reason why I believe most everyone out there is actively chasing for yield, with little or no regard for capital preservation.

It’s no secret to anyone that the stock markets are priced for perfection right now. Hard to imagine, but historically speaking, all markets behave like sine waves and go up and down. Predicting when the turn will happen is it an impossible task, but sooner or later it will happen…

As for myself, I would like to believe that I am a macro investor who takes advantage of buying low and selling high. I am in no way, shape, or form trying to suggest to anyone that this is easy to do but my track record should clearly demonstrate that I have attempted to practice what I preach.

  • I purchased real estate in 2012 and started selling off properties in 2016 and 2017.
  • I purchased stocks in 2009 and sold everything in 2015.
  • I purchased mining stocks in 2015 and that is my current focus.

Nothing in this world is really black or white… Just because you take one course of action does not mean that you have to be solely fixated on that single path alone (I still own a bunch of rental properties for cash flow less anyone forgets). Yes, it is true that I have an affinity for cheap mining stocks these days but readers should keep in mind that over the long-term I am at the same time ALWAYS contemplating my ultimate exit strategy. I am not devoted to any single asset class, and I look at mining stocks as nothing more than a means to an end… Hopefully a spectacular end result.

So what does this all has to do with passive income?

Well, when I look around me I see nothing of real interest… Here is my logic and what keeps me on the sidelines.

Real Estate:

  • Bay area real estate is priced for perfection and the upside is very limited. It is impossible to get cash flow with a conventional 20% downpayment on a rental property. Sure, someone could probably make it work by going in with a ridiculous 30%, 40%, 50% downpayment, but I have to keep disciplined here with my approach. If the market says you have to bend to make things work, it is not an attractive proposition. We are not talking about deep value investing here, so the risk vs. reward is skewed heavily towards the risk side of the equation. Screw that shit! I’ll gladly pass.
  • I could go out of state and purchase Class B/C rental properties in the Midwest. However, first hand experience has demonstrated to me that the overall Return On Investment (ROI) is actually quite low with these cash flow rentals at this particular moment in time. To make out of state rentals a success story, you really need to take a hands-on approach or have boots on the ground working hard for you day in and day out. Further, I am a person who has been mightily spoiled with capital appreciation and rent appreciation through the years from my Class A Bay Area properties. Thus, my standards are very high and I don’t like the idea of purchasing properties that offer very little reward in terms of appreciation growth. Everyone needs to keep in mind that rental properties are by nature considered Buy and Hold Forever type of investments. Therefore, these assets need to become increasingly more valuable over the years; it is not Day 1 cash flow that matters, it is Year 10, Year 15, Year 30, etc. that do!

Here’s a real-life example…

Rental Property #1:

2012 Bay Area Market Rental Rate: $2,130/month

2017 Bay Area Market Rental Rate: $2,800/month

Rental Property #4:

2013 Indianapolis Market Rental Rate: $1,075/month

2017 Indianapolis Market Rental Rate: $950/month

You tell me which rental property was the better purchase… and that’s before even considering the MASSIVE capital appreciation that the “better” property also provided in spades! Live and learn…

  • Also worth noting, the actual property/structure will only degrade over time which means you will need to allocate more and more capital towards repairs/maintenance, so if your cash flow/home-equity is not rising significantly more to offset those costs, the investment is a losing proposition. Out-of-state properties are a “grind it out”, “slow-and-steady” type of investment approach and I feel like I have more than enough of them in my portfolio to want to own anymore. Yes, right now I am glad that I own some of them because they actually cash flow quite well (~8% annually), but I think I can do much better. I am generalizing here, of course, and it’s extremely difficult to stereotype an entire region… I’m sure there are select pockets that offer better opportunities, but given how hot real estate is as a whole right now (mom and pop and everyone you know is interested in buying rentals), it’s a “needle in a haystack” type of proposition which is something I am not interested in. I could step up my game and target Class A rentals in the Midwest, but again, I don’t want to chase the markets right now, so that option if off the table too.
  • When it comes to real estate, I desire to own properties that can offer a combination of both capital appreciation and rent appreciation. Trust me, you want the best of both worlds (see my example above; capital appreciation and rent appreciation go hand-in-hand. Properties that can’t offer one won’t offer the other!). If I can’t find that, I have no problems with sitting on the sidelines and waiting out the market until I can get what I covet. There is no need to rush into mediocre investments. Real estate is extremely illiquid and difficult to sell. It is like checking into Hotel California so if you are going to do it you had better have conviction with your purchase. I have zero conviction right now in real estate rental properties… So, I’m simply going to play the waiting game.
  • Buy low, sell high.

Stock Market:

  • Similar to real estate, right now the major stock indices are all priced for perfection. Use any valuation metric that you’d like, the Dow Jones, S&P 500, Nasdaq are not cheap at all… Not by a long shot. In an ideal world, if I was going to get back into stocks I would just buy ETFs and “set it and forget it.” Let’s be real here — When you are in early FI, you just want to go on autopilot whenever you can. When it comes to Buy and Hold Forever, we all know that nobody can beat the market over the long haul, so I don’t even want to bother to try. I just want to achieve some semblance of a yield with a reliable ETF product. Unfortunately, the markets are all super expensive, so again just like Bay Area real estate, I am going to have to exercise a great degree of patience here until we get much better buying opportunities. I would need to see a major market crash happen before I even consider jumping back into the fray.
  • The alternative route, I guess, is that I could target individual dividend stocks like the majority of early FI bloggers out there do… Again, this would take a bit of research and work, and I’m not convinced that it is worth all the effort involved. Over the years, I’ve learned that I am a firm believer in total returns and feel that they are far more important than annual yield. Just like with real estate, it is important for investors to be able to find investments that offer both capital gains and passive income growth potential. I don’t want to own a portfolio of high-yielding, no-growth stocks such as: AT&T (T), Emerson Electric (EMR), Procter and Gamble (PG), etc. It might sound cruel to say, but in my eyes those investments are all instant reward today and very little reward for tomorrow type of assets (best left for folks already in early FI not for those who are trying to get there ASAP).

Anyone can pull a chart out of their ass to support their argument… Here’s my attempt at “cherry picking” timelines… Anyway, look at the 5 year chart below and you’ll get my drift (remember I’m the guy who believes without a doubt that the path to early FI is paved by net worth and not passive income/cash flow).

On the extreme end of the spectrum, just entertain the thought of having placed major bets into: Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Tesla (TSLA) five years ago instead of chasing after no-growth/high-yielding assets… You would have achieved early FI yesterday (or the day before)…

  • But next to nothing in stocks is cheap today, so bottom line as usual — “Buy low, sell high.

Mining Stocks:

  • Unfortunately, I have no interest investing in real estate or stocks right now. On the flipside, I see tremendous value being offered up with mining stocks, just like I have over the last two years. So, nothing has changed in this regard. With the most recent smackdowns (the market really hates this asset class, for whatever reason), I’m starting to feel like precious metals mining stocks are back into the early stages of the 2nd inning now. In other words, we’ve got a long ballgame ahead of us. I understand that seeing your portfolio ripped to shreds by the market over the short-term is a difficult pill to swallow, but that’s just how the game goes sometimes… Obviously, mining stocks stocks are not for everyone, and you seriously have to have an iron stomach if you are going to play in this space, but I honestly don’t see better value anywhere else. These mining stocks are entering “piss cheap” territory again.
  • In the big picture, early FI is all about cash flow/passive income… I realize that completely… I am not that insane and delusional to dismiss that undeniable truth, contrary to popular belief. In fact, believe it or not, I am so fixated on the thought of securing a robust and sustainable cash flow/passive income stream for perpetuity, that it is this end game in mind that keeps me pushing forward with what I’m currently doing.
  • Don’t chase markets, let them come to you. Whenever in doubt, “buy low, sell high.” Mining stocks are pretty fucking low right now (morale and share price)…

 

I came across this awesome quote earlier today, but unfortunately I didn’t jot down the source…

 

Here it is, anyway:

 

“Most people invest and then sit around worrying what the next blowup will be,” he says. “I do the opposite. I wait for the blowup, then invest.”

 

Fight On!

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RiadaJohn @ passiveguy.comNo Nonsense LandlordOliver @ Appreneurinvestor.comJC Recent comment authors
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Joe
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Joe

Are you in early FI or still trying to get there?

Nick
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Nick

Are you concerned that mining stocks could get caught up in an overall market correction? Especially given how expensive the overall market is?

passivecanadianincome
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good post, great example on the real estate. Here in the gta everyone is rushing to buy houses as they go up in value at ridiculous rates. I don’t see it continuing and cant find any great cashflow properties at the moment. Mining stocks I find are hard to hold as their yield is way to low but i agree with buying stuff beat up. Metals were crushed early last yr and i bought some russell metals and have done very well on that.

DivHut
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Nice write up. It just highlights the differences we all feel when it comes to investing. Chase yield, growth, both? Real estate? Buying high flying volatile tech stocks that are either huge winners or big time losers. It all comes down to risk tolerance and risk/reward ratios one must feel comfortable with. For some that means sitting on cash and waiting or for others full steam ahead no matter what.

JC
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Excellent write up and honestly I couldn’t agree much more which is why I haven’t been making any serious purchases recently. While there’s some solid companies that are trading around fair value from time to time I also realize that eventually the sentiment will change for the markets. The post election move is essentially baking in that everything that Trump promised is going to happen and then some, yet even if it does there’s going to be lots of issues to get around. If the YUGE tax cut takes place without a subsequent cut in government spending how in the world are we going to deal with those kind of budget deficits without inflating our way out of the problem? That’s a plus for precious metals.

One gripe I do have though is regarding the price change chart. Price change is only part of the TR formula which you mentioned is your preferred metric while getting to FI. So a more fair comparison would be a TR chart of course companies like T, EMR, and PG will still get blown out of the water, just not as badly.

Overall though there isn’t a whole lot to like with most traditional investments. And as you well know stepping into the PM mining space is crazy volatile. I don’t have the time to really research these companies through and through and it seems like for the most part you’re betting more on successful people in the space than anything else. I have been tipping my toes into the area though via options on GLD, GDX and GDXJ because my thought is that there’s a lot more reward to the upside than there is risk to the downside which is the kind of situation I want to be in.

All the best.

Oliver @ Appreneurinvestor.com
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Love your blog. I’ve been following it ever since I saw your posts a while back about turn-key properties. I purchased an undervalued fourplex that needed fixing in LA at the beginning of last year and it’s appreciated a good amount. I’ve been on the fence about turn-key properties since they focus on cash flow and I don’t need to worry about market swings as much, but I still haven’t pulled the trigger.

I’m sitting on a good amount of cash right now waiting for a correction to happen to both real estate and the stock market. It’s painful seeing cash not being put to work and having my personalcapital account nag me about having too much cash. Like you said, it’s about buying low. I know timing the market is too hard, so I semi-stick to my long term plan (Vanguard’s plan), but at the same time…I just can’t get myself to put in anymore money to either real estate or the stock market right now.

I’ve had decent success in apps, but it boils down to being a smart investor to generate true wealth. My asset allocation in Vanguard is 70/30…but I have a lot of investments outside of Vanguard, so lately total asset allocation is 50/50 (with a good chunk in cash). I’m patiently waiting. Good luck to us all! 🙂

No Nonsense Landlord
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My Midwest real estate portfolio has done me extremely well. I make well over 6-figures after all expenses are paid.

I think your property managers have mis-lead you on the purchase and the management. Low income properties are almost impossible to make money on.

John @ passiveguy.com
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Love the blog and hearing your perspective , especially since you are someone actually living it. As someone living in Oakland,CA and working in SF , I endure a very high cost of living , a debatable standard of living, and no real FI insight as a wage based worker , which got me started down this path. I’m curious what you mean by ‘amplify cash flow by not focusing on cash flow’. Also curious about your opinion of triple leveraged ETF like JNUG and DUST. They seem highly manipulated. Wonder if you feel the same about your own mining investments.

http://passiveguy.com

Riada
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Riada

Hi FI Fighter,

Great post..I particularly enjoyed the thought of total returns in the long run vs. instant gratification through yield/dividends…

My question to you…if Trump cuts corporate tax rates, would stocks suddenly appear cheap again, and would it peak your interest? As you said, it’s becoming difficult to find a deal right now.

It would also be interesting to hear your thoughts on the Canadian housing market, more specifically the Toronto/GTA housing market, if you’ve been following..

Cheers.

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