Passive Income, Why it Works and How To Use it to Your Advantage
A guideline for using passive income to create choice and freedom in your life
The key to creating more choice and freedom in your life is passive income! It’s what’s going to change your life in ways you never imagined.
So what is passive income?
Passive income is a regular flow of money that doesn’t require a significant commitment of time, money or energy to earn. In other words, it doesn’t require you to do much ‘active’ work.
Passive income is not……
Your job or a second job – you are exchanging your time for money here. If you take your time away the money goes away.
Passive income does require some initial capital and/or an upfront time commitment. This may include research into dividend paying shares, high yielding bonds, where and the type of property to purchase, how to rent out your house or apartment or car. It is important to consider diversification, you can read more about that over here.
The power of compounding works from the very beginning, but becomes more and more noticeable over time. This occurs when you re-invest your income (dividends) so your money is making you money and then that money is making you more money.o.
Types of Passive Income
Dividends from Shares
You can purchase dividend paying stocks indirectly through Exchange Traded Funds (ETF’s) or managed funds.
Dividend focused ETF’s or managed funds allow you to spread your investments across a number of dividend paying companies in different industries and geographical locations providing you with diversification.
A benefit of creating passive income through dividends from shares is the ongoing costs are generally very low compared to property.
Interest from term deposits or bonds
In recent years, passive income on cash or fixed interest has been extremely low due to low interest rates. In recent months, interest rates have risen and as such interest on Term Deposits also have.
Term Deposits are where you put your surplus cash in the bank or credit union for a fixed term and you receive an interest payment. You cannot access these funds without penalty during this time.
Bonds are a form of lending; it is where you loan money to a government or company and in return you receive regular interest payments until the end of the loan period when you’ll receive your initial investment back.
Bonds require a higher initial investment amount than a term deposit, however you can invest smaller amounts in bonds through a managed fund or exchange traded fund (ETF).
Note these values will move with global interest rate movements and therefore fluctuate in value. As bonds are defensive assets, their volatility is generally less than that of a share or share fund.
When interest rates rise, the market value of the bond falls. That is, if you were to sell that bond on the secondary market.
Along with shares, term deposits and bonds are amongst the most passive of income streams you can have. It’s important to note however, they have different risk associated with them.
Rent from property
It’s no secret that Australians have a love affair with property and owning property is known as the great Australian dream. In this section, I’m talking about owning an investment property to rent out (that you don’t live in).
Passive income is created through the rent that tenants pay to live in the property. Unlike shares, there are more ongoing costs to owning a property.
- council rates
- water rates
- insurance
- maintenance and repairs
- fees paid to an agency to manage the property on your behalf
Usually buying an investment property involves borrowing money, the interest costs are also an expense of owning the property. There’s stamp duty, land taxes and other government fees and duties as well.
Let’s talk about some common terms when it comes to property.
Negative gearing means the cost of owning the rental property (the expenses) exceed the rental returns you receive (the income).
If you have a negatively geared property, you are able to deduct the losses against other income such as salary or wages.
You receive a tax benefit because the property is losing money. Some people are willing to do this on the expectation that the value of the property will increase in value.
These gains, called capital gains are taxed differently at the time you dispose of (usually sell) the property.
Positively geared properties is when the rental income exceeds the costs of owning the property.
You will pay tax on the income earned from the property.
The Loan to Value Ratio (LVR) is the value of your home loan as a percentage of the total value of the property.
For example, if you have a $350,000 loan on a property valued at $500,000 your LVR would be 70%.
Due Diligence is a term used to represent your investigation and review of the facts provided to you. It’s important to do your due diligence when purchasing any asset.
If your goal is passive income, then your property needs to be positively geared. It needs to be generating cashflow and putting money into your bank account each month, not taking money out of it!
This means the rent needs to exceed ALL of the outgoings.
Rental yield can be broken down into the gross yield and net yield.
Gross rental yield is annual rental income divided by property value multiplied by 100.
For example, if you are receiving $500 per week rent, your annual rental income is $26,000. If the property value is $500,000, your gross yield is 5.20%
Gross Yield = [Annual rent / Property Value] * 100
Gross Yield = [26,000 / 500,000] * 100 Gross Yield = 5.20%
Net rental yield includes all expenses. It is calculated by annual rental income less expenses divided by property value multiplied by 100.
For example, if you are receiving $500 per week rent, your annual rental income is $26,000, your expense are $20,000 per year and the property value is $500,000, your gross yield is 1.20%
Net Yield = [(Annual rent – expenses) / Property Value] * 100
Net Yield = [(26,000-20,000) / 500,000] * 100
Net Yield = 1.20%
Like any investment, it’s important to consider the pros and cons of owning property.
Alternatively, if you’d like to have exposure to the property market but don’t have the upfront capital or don’t want the hassle of owning a property, you could invest in listed property funds such as an Australian real estate investment trusts (A-REITS).
These work similarly to managed funds where you may receive distributions which are similar to dividends.
Income from renting out assets
Renting out a room or rooms that you don’t use for a specific duration can bring in some passive income.
Platforms like Airbnb or Stayz allow you to set the terms and connect with people who may be interested.
You can hire a property manager to manage this on your behalf, making it truly passive. Obviously, this will be an expense and reduce the amount of income you receive.
You could also rent your car out through car sharing companies such as Car Next Door or GoGet.
Or consider renting out your car space if you live in a central location or your garage, shed or driveway for people who need to store things.
I talk about ways to get started building passive income over here.
By learning how to build passive income, you open up a world of possibilities – a life full of choice, freedom and independence. So babe, if you want some help creating true wealth and building passive income streams, I’d absolutely love to support you.
You can book a call to discuss ways we can work together but clicking the link below.
Together we will get clear on your vision, understand your financial freedom figures, create an action plan and you’ll build confidence in creating true wealth by cultivating financial intelligence.
I can’t wait to support you in transforming your financial reality.
This is general information and for educational purposes only.
