Earning passive income is an investment strategy that creates wealth gradually, without having to spend your whole life working for it. Applied correctly, you could earn money whilst sipping pink margaritas under a palm tree in the Bahamas.
Although it’s not quite as simple, it is nevertheless an important source of income. This is especially true for anyone who worried about not earning enough from their salaries to retire independently in future. It is income in addition to your salary, regardless of what you earn as an employee or contractor. This income can be from rent, royalties or shares that pay monthly dividends. This is where your money generates more money without much effort from your side.
Do you work for your money, or does money work for you?
You may work sixteen hours per day and so exchange your time for money, but there are limits. There are only 24 hours in a day and if you work non-stop, you could burn yourself out without a guarantee of achieving financial freedom.
Do not work harder… work smarter!
Passive income is a smart and relatively effortless way to generate income and improve the quality of your life. It makes you less dependent on your salary and allows you to spend more time with your family, play, sport, travel or whatever hobbies you may want to pursue. If you do not work smarter, there will always be a limit to your wealth. Similarly, you can only become financially free if you create a source of income that does not consume all your time.
Patience creates wealth
Passive income can come in the form of a buy-to-keep investment. Active investments pursue short-term gains. However, they demand that you keep a constant eye on markets and try to predict what is going to happen next. It costs you time and money. In contrast, passive investment rewards you over the long term with wealth gradually building up. It takes time and patience, and the earlier you start the greater the reward.
No such thing as a free lunch
People are often surprised by the initial amount of time, work and money that is required to earn a significant source of passive income. However, nothing in life is free and earning a passive income requires you to earn money before it can work for you. The risk is that you may harm your monthly source of income if you spend too much time or money building passive sources of income outside of your 9-5 job.
Rental property versus dividends
Investment in rental property is often believed to be the ideal way to earn passive income. But it is important to consider what return can be expected in relation to costs, expenses, and the financial risks property ownership.
The risk involves key questions: Is there a market for that property? Will your tenant pay promptly? If not, can you evict your tenant? Will the tenant respect your property or damage it? Can you sell the property quickly? Will the rental income cover the bond repayments, maintenance and other costs?
An engineer from Somerset West bought ten apartments in the university town of Stellenbosch over a period of twenty years. He obviously believed that property was a better investment than an investment in equity. This year, he had a wake-up call when, for the first time, he could not increase the rental income by the usual ten percent. That was because new student residences and private blocks of flats arose and some of his flats ended up being vacant. Many students who rented from him just dropped out and disappeared, while others were in arrears with their rent. Vandals damaged some of his properties and he now spends so much time taking care of his properties that his engineering practice is suffering.
Meanwhile, his rental income attracts income tax, as well as transfer duties and capital gains tax upon the purchase or sale of each property. Considering the myriad other costs like levies, municipal service fees, state agent commission etc., the reward may not be worth the effort.
Unlike rental property, shareholders of dividend portfolios enjoy a monthly income based purely on the growth of the companies in which they hold equity. The risky part is choosing the right shares. I.e. shares that do not put your capital at risk, whilst still ensuring a reliable monthly income.
Passive income from a preference share investment
Someone who is interested in a passive income could consider Ecsponent’s preference shares. These shares pay a fixed monthly dividend. You receive a 100% capital allocation and do not have to spend time constantly making changes to the portfolio. You have peace of mind knowing exactly how much and when your dividend will be paid, based on a JSE-issued dividend calendar. In addition, the dividend tax is already deducted, which is considerably less than the income tax payable on rental property for most people. Clearly, you earn more with Ecsponent and without all the effort and stress of managing rental properties!
Decide when you want to retire
Passive income sources with predictable payments afford you the control to decide whether you want to retire sooner or later. With passive income, you earn more than you put in, and your time is not proportional to your income. All it requires is prudent planning well in advance and eventually, you can sit back and reap the rewards.
Time gives you freedom
Passive income gives you the freedom to decide how you wish to spend your time. You could work for the enjoyment, spend more time with family or pursue new interests. Or learning new things, celebrating life and achieving your dreams. In this way, you do not only work smart with your time but also your money!