Financial Advice Blog

How to unlock the power of passive income

With the rising cost of living, many are looking to supplement their income. The good news is, that there are more opportunities than ever to generate passive income. Brenton Tong shares some options in this article with Sydney Morning Herald.

Financial Spectrum’s Brenton Tong was interviewed for this article by Simon Webster published in Sydney Morning Herald.  You can view the original article here.

With the rising cost of living coming into sharp focus, more and more of us are looking for ways to supplement our income. Yes, you could ask to work more hours or find a second job, but this isn’t always practical.

You, like many Australians, might also consider setting up some passive income streams, which will continue to produce income in the background, even while you’re working a 9-5, are taking parental leave, or enjoying a career break.

The good news is that there are more opportunities than ever before to generate passive income, thanks to easily-accessible wealth-building tools and education resources.

In saying that, let’s be clear: if you’re just starting out, passive income isn’t going to transform your life overnight. But in time, it can be a game-changer, says Brenton Tong, director of Sydney financial-planning firm Financial Spectrum.

“Passive income is like having a little squirrel working hard all day long and pumping out little bits of money for you,” Tong says. “It’s their effort, not yours.”

Passive income is different to capital growth, Tong says. If you own shares or property that go up in value, you don’t get the benefit of that growth until you sell them. But if those shares or property produce income, you get that in the form of ongoing payments – and you have the choice of reinvesting it or using it to pay bills or improve your lifestyle.

“Compounding is really what brings home the long-term benefits,” Tong says. “The income you earn from your investments, when invested again, will produce more income. This in turn gives you more to invest next year, which allows you to build up your assets faster and faster.”

So how do you go about earning passive income? Here are some ways.

Consider dividend-paying stocks

With the rise of online brokers, getting started on your investing journey has never been easier. But first, one must consider which types of stocks are most aligned to your goals. While some companies do offer dividends, some are solely focused on growing their investors’ wealth through share price increases.

Dividend-focused stocks are usually offered by more established and stable companies that can afford to pass excess profit to their shareholders. For instance JB Hi-Fi (ASX:JBH) last month announced a $1.97 per share dividend.

Growth-focused stocks are generally considered as those from earlier-stage companies with the potential to grow at a faster pace than the rest of the market. These companies typically reinvest their profits into the business to fuel growth, rather than paying out dividends. For instance, US-listed Uber (NASDAQ:UBER) does not pay a dividend, but seeks to provide investor value through product innovations and increasing its market share.

In reality, most investors take a blended approach, with an allocation across different companies depending on their objectives and time horizon. For instance, those looking for passive income may have a larger allocation to dividend paying stocks when compared to those focused on long term wealth creation.

“You can buy any number of shares, so it’s easy to start with a small amount of money,” Tong says.

Explore index funds

Index funds (namely EFTs that track a large stock index) are among the most popular options for passive investors. For instance, a fund that tracks ASX 200 will have exposure to Australia’s largest 200 companies, pool the payments of all the companies in the fund, then distribute dividends among holders at regular intervals – usually every six months.

You could also consider buying units in income-focused exchange-traded funds (ETFs) that seek to maximise yield by tracking a range of high dividend-paying stocks.

While they can be a great option, Matt Leibowitz, CEO of online broker Stake says, “specialised income-focused ETFs are more actively managed and tend to have higher management fees when compared to broader index funds. So like any investment it’s important to weigh up the pros and cons before deciding on your approach. The ETFs that you choose to invest in will ultimately depend on your time horizon, financial goals and risk profile.”

Bond ETFs have also become more popular over the past year. These products generally offer monthly coupon payments from a basket of bonds, as opposed to the three- or six-month payments commonly offered by dividends. Bond ETFs are available through several different formats, such as treasury, corporate and floating-rate options.

Get a slice of the rental market with REITs

Buying an investment property, paying off the mortgage, then living off the rent is a classic investment strategy. But managing tenants, seeing to repairs, dealing with property managers and finding the best investment opportunities can be a lot of work.

If you aren’t looking for an investment property but are still interested in real estate, Leibowitz says that real-estate investment trusts (REITS) could be an option. Essentially, you’re investing in a trust that buys property using investors’ funds, then distributes the rental returns to its members.

“REITs allow investors to earn a portion of the rental income and capital growth generated by the underlying properties,” he says. You can buy units of REIT ETFs via the stock exchange, just like buying shares.

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