3 Best Investments To Build Passive Income
KEY TAKEAWAYS
- The best ways to build passive income is through investing in Bonds, Exchange Traded Funds (ETFs) and Real Estate Industrial Trust (REITs).
- Building passive income through investing can help you build generational wealth.
- Wealthy individuals build their wealth through passive income investing.
Finding the best investment for passive income this year? There are many investments that can help make you wealthy, but only a few can generate passive income which helps you find financial freedom.
Imagine earning USD$37 Million a day, USD$428 per second doing nothing.
Do you think it is possible?
Well, Yes! In fact, Warren Buffett made USD$37 million every single day, passively.
Warren is not just good at investing, he is great at finding dividend-paying stocks and other investments that help him make money over time. He is the legend of value investing, a master at dividend investing, and his mastery of investing, has made him a multi-billionaire.
Best Way To Invest For Passive Income
Investing for passive income is becoming increasingly popular among people hoping to make money without actively trading stocks or other assets. Creating passive income is an important part of a healthy financial strategy.
When invested in the right investment, a passive income can provide financial security, a great way to create a passive income stream for your retirement, an income source that allows you to live the lifestyle you desire while earning money passively.
There are many investment opportunities available when it comes to investing for passive income, thus I will like to introduce you to the best passive income investments you should consider that are perfect for beginner investors.
- No active management of your portfolio.
- No in-depth investing knowledge is needed.
Bonds
Bonds are an investment instrument where you will be lending money to a corporation or to a government. The borrower will give you predetermined interest payments that are to be paid to you for the loan period. At the maturity of the bond (end of bond), your initial capital together with the last interest payment will be paid to you.
Bonds are generally considered a lower-risk investment when compared with stocks, but a great way to generate income without being actively involved in the process.
High-quality bonds are generally bonds that are backed by a government or issued by blue-chip companies. These bonds have a low risk of defaulting and smart investors buy them.
Low-quality bonds are generally issued by small companies and are generally called ‘junk bonds. These ‘junk’ bonds’ are at a higher risk of defaulting and smart investors will not buy them.
3 independent bond rating services identify which are high-quality bonds and which are ‘junk’ bonds.
These agencies conduct a thorough financial analysis of the company or organization that issues the bonds.
Set of criteria used by most bond rating services.
- Ability to grow the company or organization.
- Ability to pay back debt, aka. defaulting risk.
- The general financial health of the company.
These independent agencies will issue an overall rating of the bond.
What is a high-quality bond?
High-quality bonds are rated as investment-grade bonds. They are viewed as a safe and stable option for investment. Many people who are not as risk-averse generally choose to invest in this type of bond.
Such bonds are often tied with backing from the government or major corporations. These investment-grade bonds are often given a high rating:
Fitch Ratings Inc.
- “AAA” to “BBB-“
Standard and Poor’s
- “AAA” to “BBB-“
Moody’s Investors Service
- “Aaa” to “Baa3”
Investment-grade bonds tend to see bond yields increase as ratings decrease.
One example of such a bond is the U.S. Treasury bonds, “AAA” rated bond securities.
These bonds usually give 0.1% to 10% annual return.
What is a low-quality bond?
Low-quality bonds are non-investment grade bonds that are commonly called ‘junk bonds”. These bonds do not have healthy financial health and have a higher risk of defaulting which lead to the investor losing all invested capital.
Such ‘junk bonds’ are usually of higher risk and are usually not recommended for investment. These non-investment grade bonds are often given a low rating:
Fitch Ratings Inc.
- “BB+” to “D“
Standard and Poor’s
- “BB+” to “D“
Moody’s Investors Service
- “Ba1” to “C”
Non-investment grade bonds are usually extremely high in yield. Often, unsuspected investors which invest in these bonds will be left with nothing.
When the bond issuer is forced to close down due to liquidity issues, the investors losses their invested capital.
These bonds usually give a 5% to 50% annual return.
I will not want to buy these “junk bonds” due to the risk of default is much higher when compared with a good quality bond.
Example
Let’s say you have decided to invest in a good quality bond that gives a 5% return annually with a maturity of 10 years.
You invested $10,000 in the Good Quality Bond.
With an average annual return of 5%, you will get $500 passive income through investing in bonds.
This $500 will be your passive income paid to you for the next 10 years (A total of $5,000). On the 10th year of the maturity of the bond, your initial invested capital of $10,000 will be paid to you.
This means by buying a Good Quality Bond, your initial investment of $10,000 earns you $5,000 in 10 years without you doing anything!
Let’s look at a scenario where you start investing in bonds.
You invest $10,000 into 10 of these good quality bonds that give you a return of 5% every year.
- Total Investment: $100,000
- Total passive income annually: $5,000
Getting $5,000 annually without doing anything sounds pretty good if you ask me. It is like getting an extra month of pay every year for you to take your family travel or to buy that watch you have always wanted.
With $500,000 invested, you will have $25,000 passive income annually which will probably be enough for a simple retirement in your 60’s.
Investing in good quality bonds is probably one of the safest ways to earn a passive income for your retirement.
Exchange Traded Funds
An exchange-traded fund (ETF) is a form of index fund that tracks a specified basket of underlying investments. It is designed to mirror the performance of the underlying index they track.
Investing in ETFs is one of the best passive income strategies anyone can adopt.
ETF Examples
- S&P 500 ETF – Measures the stock performance of 500 large companies listed on stock exchanges in the U.S.
- Russell 2000 ETF – Measures the stock performance of 2,000 smallest-cap American companies
- Wilshire 5000 ETF – The largest U.S. equities index
- MSCI EAFE ETF – Basket of foreign stocks from Europe, Austral, Asia
- Nasdaq ETF- Measures the stock performance of Nasdaq
- Dow Jones Industrial Average (DJIA) ETF – Measure performance of 30 large-cap U.S. companies
- Nikko AM STI ETF – Measure performance of FTSE Straits Times Index of Singapore
- iShares MSCI Hong Kong ETF – Measure performance of stocks composed of Hong Kong equities
Advantages of Exchange Traded Funds (ETFs)
- Passively Managed
- Low Expense Ratio
- Diversified
- Low Stress
- Perform better than many retail investors
- Pay dividends yearly, quarterly, or even monthly!
Disadvantages of Exchange Traded Funds (ETFs)
- Returns fluctuate with the market cycle
- Suitable for people who invest for at least 10 to 20 years
The average return of the S&P 500
- 30 Years at 6.73%
- 10 Years at 8.18%
- 1 Year at -4.38%
Annual returns over a short period of time can vary, but over a period of 10 to 30 years, you will get an average of 6% to 8% annual return.
ETFs are the most common way to generate passive income for most retail investors. The amount of passive income depends on the collective dividend issued by the underlying stocks on which the ETFs consist.
Depending on each ETF, some may provide monthly income, while others will distribute their dividend on a quarterly, or annual basis.
Example
In your first year, you invested $10,000 in ETF.
With an average annual return of 6% to 8%, you will get an approx. $600 to $800 passive income through investing in ETF.
For the subsequent years, you invested $10,000 into the ETF every year.
After 10 years of investment, you will have placed 10 times $10,000 in ETF.
With a simple calculation, you will have around $100,000 invested in the ETF, which gives you an annual return of $6,000 to $8,000 passive income from your investment.
But if you reinvest all your dividends and did not withdraw a single cent from your investment for the past 10 years, the numbers will blow your mind.
With the help of a compound interest calculator. The total amount invested in the ETF with a return of 6% to 8% will be approx $140,000 to $156,000. This translates to $8,400 to $12,480 passive income per year!
Let’s look at a scenario where you start investing in ETFs.
You start investing $10,000 in ETF at 30 years old and reinvest every single cent for 30 years.
You have decided to retire at the age of 60 and start to live off the passive income from your investment. How much passive income will you get then?
- Annual investment: $10,000
- Investment duration: 30 Years
- Investment average annual return 8%
A simple calculation using the compound interest calculator shows that you will have grown your ETF portfolio to a value of approx. $1,200,000 ($1.2 million).
If you calculate it carefully, for the past 30 years you have only invested $300K in the ETF.
But because of a compound annual return of 8%, your investment has grown to $1.2 Million. This simple investment strategy has just earned you $900K in 30 years.
With an annual return of 8% per year from your ETF portfolio value of $1.2 Million. It is calculated to be $96,000 passive income per year!
At age of 60 years old, it is the perfect time for your retirement!
Do you think you can live comfortably with a $96,000 per year passive income?
I surely think so.
Editor’s Recommendation: How much do you need to Retire Today?
Real Estate Investment Trusts (REITs)
Real Estate Investment Trust (REITs) allows you to start investing in real estate with just a few hundred dollars. Regulated by the government to ensure 90% of the net income is to be paid to the investor, REITs are one of the best investments to generate passive income.
REITs give you the benefit of being a landlord by having a consistent stream of rental income in the form of dividends flowing into your bank. While taking away most of the headache that comes with becoming a landlord, that requires a huge upfront investment and managing the tenants.
REITs generally consist of more than one property and are managed by a team of professional property managers, making this passive income source truly passive. An alternative investment that let you make passive income from real estate.
Advantages of REITs in building passive income
- Passively Managed
- Growth potential
- Diversified
- Low Stress
- High dividend yield
- Pay dividends half-yearly, quarterly, or even monthly!
Disadvantages of REITs in building passive income
- Dividend yield fluctuates with the market cycle
- Suitable for people who invest for at least 10 to 20 years
The average return of REITs
- The average dividend yield is 5%
- The average annual return of 11.8%
PS. Some REITs can have a high dividend yield of over 10% or more during the market downturn.
REITs is one of my most loved form of investment, and thus I have written a whole list of articles on REITs.
Highly recommended you read ‘Risk and Benefit of REITs‘. You will definitely find something interesting in the article which can be beneficial to you.
Example
For simplicity the return of the REITs is as follows:
- 5% Average Dividend Yield
- 10% Annual Growth Rate for REITs Portfolio
In your first year, you invested $10,000 in REITs.
With an average dividend yield of 5%, you will get an approx. $500 passive income through investing in REITs for the first year.
For the subsequent years, your REITs portfolio grows by 10% year-on-year while giving you an annual dividend yield of 5%.
After 10 years your initial investment of $10,000 in REITs will have grown to $25,937.42! Your annual dividend received of 5% will become $1,296.87!
Your dividend yield on cost will be a whopping 12.96%!
Let’s look at a scenario where you start investing in REITs.
You start investing $50,000 in REITs at 30 years old and the REITs grow 10% every year for 30 years.
You have decided to retire at the age of 60 and start to live off the passive income from your investment. How much passive income will you get then?
- Starting investment: $50,000
- Investment duration: 30 Years
- REITs investment portfolio grows an average of 10%
- Dividend Yield of 5%
A simple calculation using the compound interest calculator shows that you will have grown your REITs portfolio to a value of approx $872,470.11. With only $300K invested, after 30 years you have $872K.
If you have reinvested every single cent of your dividend, the amount you have in 30 years time is even more staggering! You will have grown your portfolio to a value of approx. $4,377,049.76 ($4.37 Million).
This is the power of compounding.
With an annual dividend yield of 5% per year from your REITs portfolio value of $4.37 Million. It is calculated to be $218,500 passive income per year!
At age of 60 years old and $218,500 passive income to spend every year for your retirement sounds pretty good, isn’t it?
Happy retirement?
I surely think so.
Can Passive Income Investing Make You Rich?
Passive income investing has the potential to generate significant wealth for individuals.
With the right investing strategy, it is possible to become wealthy through passive investment. Becoming a millionaire or even a multimillionaire is totally possible. More importantly, you don’t need a lot of money to invest and generate a passive income.
With the rise of digital technologies, passive income investing is becoming increasingly popular among individuals looking to become financially independent and reach financial freedom.
The concept of passive income is based on the notion that one can earn a steady stream of revenue through low-effort investments such as rental properties, dividend stocks, and index funds.
By leveraging the power of compounding returns over time, investors may be able to accumulate a sizable nest egg.
Although we may not become a billionaire anytime soon.
You can definitely generate a decent income by investing.
Additionally, passive income investments often offer tax advantages, which can further bolster gains and improve overall financial well-being.
Generate Passive Income Through Investing
Of so many types of passive income, investing is a great way to generate passive income without active management.
Investing is an essential part of any long-term financial strategy. It’s not just about making money at the moment, but rather creating a steady stream of passive income that grows over time. The ideas on this list are some of the best investments to make passive income for beginners.
- Bonds
- Exchange Traded Funds (ETFs)
- Real Estate Industrial Trusts (REITs)
Investing through a stable, well-diversified and proven investment vehicle like ETF is my most preferred way to make passive income, which offers recurring cash flow, high returns, and inflation protection.
Earning passive income through income-generating investment may not make you rich overnight, but it is a proven way for you to become rich and possibly retire early.
In this article, we have explored some of the best ways you can actually generate passive income through investing.
Nonetheless, every action or investment comes with risk and care should be taken when performing each task.
“More You Learn, More You Earn.”
Wisdom from Billionaire Warren Buffett
Here are some resources that will help in guiding you to your success.
- Investing Books to Riches
- Business Startup Books
- Leadership Books for aspiring Leaders
- Sales Books to Wealth and Success
- Life-Changing Books to a Future of Success
Taking your First Step is always hardest, But it is the Most Important Step to Greatness
- Cash Management Account vs Brokerage Account: What is the Difference?
- Key Features of Cash Management Account
- Benefits of Cash Management Account: Unlocking Financial Efficiency and Flexibility
- 7 Streams of Income to Build Wealth Now! (Powerful Income Ideas)
- +59 Best Proven Membership Site Ideas to Get Started This Year (Read First)
Join 900+ BUDDIES who are growing their wealth with our weekly Income Newsletter
Antony C. is a dividend investor with over 15+ years of investing experience. He’s also the book author of “Start Small, Dream Big“, certified PMP® holder and founder of IncomeBuddies.com (IB). At IB, he share his personal journey and expertise on growing passive income through dividend investing and building online business. Antony has been featured in global news outlet including Yahoo Finance, Nasdaq and Non Fiction Author Association (NFAA).
