What Is Passive Income?

Today there is a lot of talk about passive income. With the F.I.R.E ( Financial Independence Retire Early) movement gaining popularity and traction more people are aware of this concept. At its core it means that you do not have to “actively” work to earn this income. In your regular day job you may have to work 40 hours a week. In exchange for your services you are paid a salary. If you don’t work for a short period of time , you will still get a salary depending upon your annual leave and sick leave entitlements. However once all that is exhausted your employer will not pay you if you do not show up for work.

Whilst passive income is exactly the opposite. Even if you don’t show up you will get the income. Examples are rental income from a property you own, capital growth and dividend income from shares you own. So these assets are making money for you even while you sleep. Some people argue that if you spend a little time to manage these assets they are not truly passive. That understanding is incorrect. You will always have to spend some time , maybe even the act of collating paperwork for your tax accountant. But in the big scheme of things this time is miniscule.

Why is this such a hot topic?

At some stage in your life, usually after a layoff or recession you evaluate how dispensable you were to your company. All those mentions and praise doesn’t seem to be so important anymore. If you are lucky, you may get a decent redundancy package and even find a job in 2-3 months.

But now there is a change in mindset…this can happen again. Rather it will happen again.

Or it could be after a sickness that you or a loved one went through. Reality hits ,life is not just for running on the hamster wheel. You want to enjoy it whilst you are still young and in good health. And so out of these feelings, came the need to create an income that does not require you to trade your time for money. It could even start off as a side hustle. That income is called passive income!

Passive Income Sources

The two most popular methods to earn passive income are shown below. It’s hard to zero in on the best passive income idea as they both have their pros and cons. Your private pension can also be considered a passive income stream. However you get this only when you retire and that beats the purpose for the FIRE followers.

Dividend Income

This is one of the most popular forms of passive income. You buy shares, ETF’s or managed funds and then you receive either an annual, quarterly or monthly dividend amount. The companies are effectively paying your share of income earned on the funds invested with them. If you have large amounts invested with these companies and they have a history of paying good dividends you will receive a healthy passive income. Do note, all companies do not pay out all their earnings as dividends. Some of them deploy them into Research & Development and plant and machinery for expansion purposes.

For example one of the biggest companies on the planet today, where most of us would have bought something from- Amazon has not paid out a cent in dividend payments till date.

However if you held Amazon shares from 2008 onwards( or the last 15 years) they would have grown by 167%. That sure beats a dividend income of 30%.( assuming 2% per year for 15 years).

Apple shares paid an approximate dividend of 0.23 cents per share held. If you held 1000 Apple shares you would have received $910 in 2022. Keep in mind your total value of shares would have been approximately $143,000 resulting in a yield of approximately 0.63%.

Your high interest saver account probably pays around 4.00% p.a. So why would you bother with Apple or Amazon or even Microsoft or Alphabet( parent of Google) for that matter. The reason is because we believe that these companies are leaders in technology and they will deploy their capital well and over the years our shares will grow enormously in value. Case in point –Amazon.

Can you believe Apple shares grew by 264 %(including dividend)over that same 15 year period. So are they a better option?

It is quite hard to put together the perfect portfolio of shares and ETF’s that will give us consistent passive income. Apple and Amazon gave phenomenal capital growth but not much dividend income.

Australian shares especially the banks and miners are known for their high dividend pay-outs.

If you had invested $500,000 in VAS ( Vanguard ASX 300 ETF) in Jan 2020 you would have received approximately $30,000 p.a in dividend income and the portfolio would be worth approximately $546,000 today. Not a bad outcome.

Do remember if you are working, this dividend income would be added to your taxable income and you would have to pay tax on it as well. There is no guarantee that you will get $30,000 in 2023 either, as this depends on how well the companies fare in the current economic climate.

Rental Income

If you have a property that you lease out for rent, the income earned is called rental income and this property is usually referred to as an investment property. This is another source of passive income as you are not actively working to earn this income. Yes, you have invested your money to buy this property but apart from liaising with the real estate agent and making some payments ( council rates, strata payments( if it is an unit), insurance etc) you are not actively trading time for earning money from this investment.

Can this be the best source of passive income ?

Unlike shares the tenant has to always pay the rent right ? We saw what happened during Covid. Landlords were forced to give a decrease or even a rental freeze for 6 months.

Again the answer is not so straightforward. In order to earn a decent passive income from properties you need to hold a fairly big portfolio of properties. The yield on properties in Australia is generally on the lower side .

For example using the same purchase price of $500,000 ( you will probably get only a unit at this price) you could possibly get rent of approximately $450/week. However after agents fees and costs the net amount could be approximately $17,000 p.a which means a net yield of 3.40%.

So to get an income around the $30,000 mark you may need two properties. Of course you could choose to rent it out yourself , in that case there would be more hours involved and you would need to upskill yourself with the law and regulation to ensure all your paperwork is in order. Even then the yield would rise to around 3.85%.

Other sources of passive income

1. House sitting – Whilst not so easy to find , with some clever networking you could land yourself in a nice suburb and a beautiful house and you may have to do some small chores like collect the mail, water the garden and feed the dog/cat. If you have a day job in an area closeby this source of income would mean you dont have to pay rent and that could increase your savings by a tidy sum.
2. E-Commerce – Setting up a Shopify store or selling products on Amazon could earn you some money, but there is a lot of learning to be done initially and some upfront investment for the stock etc.
3. Digital products – With all the noise about save the trees etc. this category has taken off. If you are quick with the computer you can whip these up quite fast. Drawing books for children and even mandala painting or mindfulness colouring for adults are niches that had good growth in the recent years.
4. Writing a book – I know this one is not for everyone. Do remember it’s much easier to self publish these days than it ever was. So if was always a dream for you..start typing.If its a success you could earn royalties for years to come.

Disclaimer

The information on this website and in the articles provided are general information only and do not take into account your personal objectives, financial situation, or needs. It should not be relied on as financial, legal or taxation advice, and is purely for educational purposes.