Passive Income Investing - The Path to True Wealth

Looking for passive income ideas and strategies? Keep reading to find the strategies used to build true wealth.

As a young person, dreams about life as an adult often revolve around high-paying jobs. Whether you wanted to be a pro athlete, a doctor, a lawyer or an entertainer, if you’ll be honest, one of the things that attracted you to your chosen dream is that all those people make a pretty good living. However, what people don’t know as kids is the difference between being rich and being wealthy. 

A rich person usually gets paid a lot of money for what they do. However, a wealthy person has money that works for them every day. In fact, wealthy people earn income without having to work at all. Why? Wealthy people understand that generating passive income, not sitting on a pile of cash, is the key to financial security. So how do you go from being rich to being h? By having a passive income strategy that includes multiple sources of income that will lead you to financial independence.  

What is Passive Income?

No matter what you do for a living, when you wake up and go to work every day, the money you get paid is known as active income. That’s because you have to actively do something to earn it, and if you stop conducting that activity, you will no longer be paid. Your ability to earn active income is contingent on your ability to physically go to work and do the job. 

Passive income is money you earn whether you go to work or not. One of the best and most common examples of passive income is rental income. If you have a finished basement in your house or a garage that you rent out for $1,000 per month, you are earning $12,000 per year in passive income. The more passive income you earn, the more real wealth you have. 

Pro athletes may get rich, but a lot of them go broke because they have no passive income. They are constantly eating into their nest egg to support themselves. Once the money is gone, if there isn’t any passive income flowing in, the house and the cars will be foreclosed on or repossessed by creditors. The fancy clothes and jewelry they flaunted to let people know how rich they were are nearly worthless secondhand. 

As people age and are no longer able to work, the importance of earning passive income increases. That’s why your goal as an investor should be not only to get rich but to create as many opportunities to earn passive income for yourself as possible. How do you invest to generate passive income? Keep reading to find out. 

Generating Passive Income Streams

Real estate

Perhaps the most tried and true method of generating passive income is through owning income property.  Even a small portfolio of four to 10 rental units can go a long way towards generating the passive income you will need to support yourself in retirement. Depending on where the rental units are and the strength of the local rental market, owning just that small portfolio might generate enough income for you to retire early. And real estate investors get a lot of great tax benefits.

The biggest barrier to buying income property is the financial investment where you will have to put money upfront. However, even an everyday working person can find creative ways to buy income property. Many states (including California) classify properties with four units or less as a single-family property, allowing you to get 30-year financing for your rental properties. You may be able to buy a two-, three- or four-unit property through Fannie Mae or Freddie Mac with only 3% down, although these types of loans have special requirements when you buy a home that you want to turn into a rental property. 

In this example, you can then live in one unit and rent the other units out. It’s your choice whether you want to use the income from the other units to pay the mortgage down more quickly or acquire another property. 

As rents and property values increase, your rental income and equity will too. In either case, by changing your focus from buying a single-family home to a fourplex, you can put yourself in a position where you earn passive income. If you can’t afford to buy a property flat out, you still have options. 

Real estate syndication and crowdfunding allow many investors to pool their money to buy income-generating properties. One of the most popular forms of real estate syndication is real estate investment trusts (REITs), which are funds that combine investor capital with their own to own and operate commercial property. 

Many REITs and real estate crowdfunding offerings have buy-ins that are much lower than the down payment you’d put on a single-family home. Real estate-focused funds allow you to buy equity in large portfolios of different investment properties. The advantage of both of these options is that you don’t have to actively manage the property. For a list of Benzinga’s best online real estate investment platforms, you can look here:

Private equity and venture capital

In private equity, you invest capital into new companies and startups in exchange for equity in those companies. If the company goes on to make money, your equity share will entitle you to quarterly earnings and dividends. 

Historically, you had to be well-connected and already wealthy to access private equity opportunities. That’s because private equity and venture capital opportunities are expensive, often requiring six-figure buy-ins. However, the rise of online crowdfunding platforms has opened the world of private equity up to more investors than ever before. 

You can choose from a number of different ways to invest in private equity and venture capital. If you don’t know anything about tech or don’t feel comfortable picking offerings yourself, you can buy into private equity funds. When you do that, an experienced fund manager will choose what the fund invests in. If it works out, you will receive distributions and earnings from the fund, which is passive income. 

The downside with private equity is risk. Most new companies and startups are not going to succeed. So, as a novice or new investor, your best option for growing passive income through private equity investments may be to buy into a private equity or venture capital fund that has a good performance history. These funds normally have their capital diversified across a number of different private equity and venture capital offerings. 

Buying debt and notes

Banking, or more specifically lending money and collecting interest, is an age-old business model for one main reason: it works. Another way to generate passive income is to buy existing debts or notes. For example, if you bought a $100,000 loan that’s paying off at 5% for 5 years, you’d get $5,000 in annual income from the interest for the term of the loan. 

This method of earning income is cash-flow intensive and risky. In most cases, people or companies who represent low credit risks don’t pay high-interest rates, which means the only way to really make money buying notes or debt is to buy loans made to risky borrowers. However, as the federal reserve continues to raise interest rates, the cost of bank financing will rise for many borrowers because lenders are paying more to borrow it.

That means the notes you buy, or any private financing you offer, will come with increased returns because you can charge more interest. But again, the only way to really profit from buying notes is to expend a lot of capital financing. In the case of notes and mortgages, your loan principal is secured by the property. If the borrower defaults, you can take the property.

So, if you buy notes on income property or duplexes and fourplexes, you could end up earning passive income from the units if the borrower defaults. The best way to buy debt is usually to invest in a mutual fund or another investment offering that has a lot of capital loaned out. Assuming the underwriters for the fund have made solid lending decisions, the coming increases in interest rates could see you gain some solid returns. 

Annuities and mutual funds 

When you buy into an annuity, you put up a large amount of capital in exchange for an annual return that you can use as income. Both annuities and mutual funds use investor contributions to grow the value of the fund, which is then returned to investors as passive income. Under most circumstances, annuities and mutual funds pay off investors on an annual or quarterly basis. 

As long as the annuity or fund hits its targets, investors can enjoy the passive income without having to take a direct role in managing the fund. The drawback here is that most annuities and high-paying mutual funds are restricted to accredited investors, meaning you will have to have a certain net worth before you can buy in. 

Final Thoughts on Building Wealth Through Passive Income

For many investors, building wealth through passive income puts them in the middle of the chicken-and-egg quandary. You want to get wealthy by generating passive income, but passive income investments usually require a lot of up-front capital. However, that doesn’t mean it’s impossible. 

For non-accredited investors, real estate or real estate syndication are two well-proven methods of generating passive income. The other advantage you have going for you is that you can access crowdfunding platforms and funds that were basically unavailable to investors as recently as 25 years ago. You can build your own diversified portfolio of real estate and startup funds. The key thing is to understand you have options. 

The best way for you to build wealth through passive income depends on a number of different variables. Talk to a financial advisor about your goals and plot a course about how to secure your financial future. It won’t be easy, but the sooner you begin concentrating on generating passive income, the sooner you can make a plan and begin executing it.