No More Procrastination: Build Passive Income Now

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Is Passive Income Real?

“Passive income” has become a buzzword recently.  The appeal of making money while your sleep certainly sounds appealing!  And perhaps
too go to be true?

If you think about it, though, everyone eventually lives off
passive income.  It’s called retirement.  Wherever income in full retirement comes from, no work is done (at the time). 

Before retirement, any passive income helps to build financial resilience.  In the unfortunate event of long term illness, extra income will prolong emergency funds.  As passive income streams increase, reliance on (and therefore premiums) income protection and life insurance fall.  

Diversifying your income streams also makes sense if your income is not 100% secure.

Should i pay for a buyers agent

Is Passive Income Taxed?

Income paid from your superannuation fund is generally tax free.  A good reason to aim to have much of your investments inside super by the time of retirement!

Other passive income is taxed at your marginal rate, except capital gains tax which is discounted 50% from your marginal rate if the investment is held for more than 12 months. 

“Capital gains” are the increase in value of an asset between purchase and selling.  An asset brought for $300,000 and sold for $500,000 has a taxable capital gain of $200,000.

Rental income, or share dividends is taxed at your full marginal tax rate. 

The first $18,200 income is tax free per person.  Meaning, if retired, both partners can earn this tax free in investment income.  A total of $36,400 for a couple tax free is a pretty good start to your passive income stream outside superannuation.  

Passive Income for Doctors and High-Income Earners

If you have a long-term stay at home partner, they can earn $18,200 annually without paying tax.  It will take quite a while to reach this with investments.  For those households that have two tax paying adults, and who are accumulating assets for future needs, it is best if possible to defer income where possible until one or both are in lower tax brackets. 

With real estate, this is part of the reason why doctors are a fan of capital growth (negatively geared) property.  Given the tax advantages and efficiency in compounding wealth completely untaxed for many years, this may be the most efficient way to build a high net worth. 

When investing in shares, “dividend investing” is very popular with lower income earners, largely due to franking credits.  It doesn’t make a lot of sense for higher income investors.  The total return of the investment is most important (rent/ dividends + capital gain).  For those on a higher tax bracket, they want to minimise income for several years.  After retirement, it doesn’t make a lot of difference if you are withdrawing dividends or capital gains (although if being taxed capital gains will be cheaper). It is still a withdrawal if you are not reinvesting dividends. 

International shares tend to produce fewer dividends than Australian indices.  And many of us are severely “Overweight” in Australian assets when taking into consideration superannuation and properties.  The Australian stock market makes up only 2% of the global market.  In the extremely concentrated Australian market, some prefer LICs such as AFIC and Whitefield for their unusual offering of dividend substituting – thereby deferring tax until withdrawal.

 

Even if you are currently an intern on a reasonably low income, when building investments consider the long term how much you will get paid. 

 

Passive Income vs Residual Income

Investors have saved and invested throughout their lives, workers have paid taxes that will eventually support them with a state pension if required.  So I’m not sure truly passive income exists outside of winning lotto or marrying a high earning spouse.  Most income streams described as passive are in fact forms of residual income – ongoing income long after the work to create it is completed.

In order to create passive income streams, you require lots of upfront work, a large amount  of time (for compounding growth) OR a large lump sum to start with. 

You will also need enough knowledge to find good sources of passive income with an appropriate level of risk for you. 

Sources of Passive Income

- Residential Property Investment

This is the probably the most obvious source of passive income.  Buy a house, rent it out and receive the rent minus tax as additional income.

Higher yield properties offer the potential to provide small amounts of passive income immediately, and come at a lower price point. 

Higher income earners may be able to take advantage of better long term returns and more reliable tenants by delaying income with good quality capital growth properties.  

The biggest difficulties with buying real estate is the huge financial barriers to entry.  You realistically need 10-20% deposit plus buying costs (~6%).  This can be in savings in equity (value of home – mortgage remaining). 

Real estate results in a poorly diversified portfolio for many years due to the size of each purchase. 

For those for which this is not realistic currently, crowdfunded real estate investing is available through BrickX or REITs. 

REITs are listed property investment funds, with less transparency and due to their liquidity tend to act similar to stocks with high volatility. 

BrickX offers more transparency, allowing you to purchase bricks of houses you are able to see pictures of.  Fees are higher, liquidity and volatility lower.   

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- Investing in the StockMarket

Investing the share market has never been easier, with barriers to entry as low as $5 with some roboadvisers.

Many consider the stockmarket “Too risky”.  Realistically though, investing in broad index funds in Australia and worldwide is a LOT less risky than putting all your cash in a single property.  Especially if that property is chosen without a lot of research.

An afternoon of research  is probably enough to make a sensible plan and pick a reasonable index fund to invest in.    

Your index fund will provide dividends two to four times a year and will initially be tiny.  You will need to reinvest dividends for many years to allow compounding to grow your income to worthwhile size.

Single stock picking takes a lot more knowledge, time and research.  The upside of potentially unlimited returns tempts many to give it a shot. 

Evidence tells us a tiny proportion of professional investors outperform an index fund over the long-term.  You are likely to lose your money if you try this first. 

Build a decent portfolio of index funds before doing further research and considering whether stock picking is for you.

Remember, being an excellent doctor (or other professional) does NOT mean you are naturally skilled at completely unrelated tasks!

- Bonds / Fixed interest

Buying bonds essentially means lending your money to governments of corporations and receiving interest like income. 

Interest rates are at record lows – great for mortgagees, terrible for retirees. 

Bonds are traditionally used to diversify and lower risk in a portfolio, and allocations to bonds increase with age. 

Rates are currently less than expected long term inflation, so in real terms bonds are losing money.  Unless rates increase significantly, I will minimize my bond allocation to that in my superannuation. 

Long term I plan to park accessible money in mortgage offsets for investment properties in lieu of a bond allocation.

- Commercial Property Investment

Commercial properties are traditionally associated with higher income (or yield). 

They can be used to tilt a residential property portfolio rich in capital gains to increase the income. 

However, there is less information around about commercial property investing. 

Commercial property rental vacancies are often months long. 

The fact that rental incomes could be wiped out completely by increases in interest rates is offputting for me. 

Commercial property is certainly an option for producing rental income, but you will need to research, minimize risk and get professional help. 

- Product development

Some doctors have made their fortune inventing medical devices. If you have a great idea, proceed carefully to ensure your employer cannot claim rights to the proceeds

-Create Intellectual Property

If you write a book, there is obviously a LOT of time and effort involved upfront.  You can potentially continue receiving lifelong residual income though.

Most published authors will attest the incredible amount of work involved, and relatively poor financial compensation, especially in comparison with your day job. 

This is something to do for passion, with income provided a side benefit.  There is too high a risk of not being able to publish or sell your finished masterpiece after so much work to go in for just the money. 

Blogs are frequently touted as a potential source of passive income through affiliate marketing and advertising. 

Writing articles regularly and maintaining a website is definitely more akin to a second job than to passive income. 

Income from this blog has only just covered basic costs in the first year.  The vast majority of blogs don’t make a profit.

Another passion project, for which any income should be a happy side effect rather than the primary driving force.

If you are a skill photographer, you could try selling stock photos.  It’s possible you already have photos that could be uploaded immediately.  But to create ongoing income you are likely to have to take and upload a huge number of photos.  It’s a lot like another job, but if you enjoy it this may be an option.

Passive income

Peer to Peer lending

I have looked at Ratesetter, now Plenti several times.  This online business allows you to invest money to be lent to people needing personal loans. 

Plenti screen the credit worthiness of the borrowers, but the investor has no input into who they loan to. 

Peer to peer lending seems really popular with young investors, but each time I look at it I can’t really see why (maybe I’m missing something?).

Currently, the top rate advertised is 6.3% for 5-year loan period.  They have a provision fund that compensates investors when borrowers default. 

But there is the risk of the provision fund being exhausted (entering a COVID recession, I would have thought significantly increasing the risk). 

In the case of provision fund being exhausted, investors can lose all their money. 

Given investing in the ASX would be expected to return higher over the long term and is associated with almost no risk of losing all your money.  It seems to me Plenti is offering lower returns at higher risk. 

- Renting Underutilised Space or Belongings

If you have a spare room, caravan, spare car, garage or even designer clothing there is probably a way to rent these items when you are not using them. 

These are inventive ways to produce passive income from items you already own.  They are unlikely to produce passive income you could expect to live on, but could well help you save for your next investment faster.

- Second Job

OK, clearly not passive.  But some extra work in your high paying profession is probably the fastest way to start building passive income streams by dumping all you earn into investments.

Buying an investment property, or investing in the stock market a year earlier could make a lot of difference. 

- Optimise Spending

The most efficient way to increase many higher income earners savings is to reduce excessive spending. 

This is not about self-deprivation, rather consciously assessing which spending provides the most value.  It is about cutting out unconscious spending that brings no joy. 

The faster you start saving, the faster you can start enjoying passive income.

Passive income is the end result of time, effort, knowledge and delayed gratification. 

Get started today building your income streams for the future.

Aussie Doc Freedom is not a financial adviser and does need offer any advise.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

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This article may contain affiliate links. If there are any in this article they are marked *. An affiliate link means if you click on the link and purchase a product, at no extra cost to yourself, I will receive a small commission.

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