Making Money Tristan on 18 Dec 2008 10:44 am
How To Generate Passive Income
There are many ways that passive income can be generated, through bonds, rental property, dividends from shares, royalties etc. Most of these require a significant amount of capital to generate a modest return of say 5%. If you’ve made the decision to get out of the rat race and become financially free, you’ll need to think about generating passive income, which is fine, but using conventional methods, this could take some time – are you happy deferring life for 10 or 20 years while you build up these assets?
Let’s take a look at a fairly typical example. Meet Steve, he’s works in sales, earning £50,000 a year. His wife works as a teacher, earning £30,000 a year. Together, after all their costs, each year they have £20,000 leftover. If they were to invest this £20,000 a year for 25 years, they would eventually have enough money invested at 5% to generate a passive income that could be used to replace their earned income.
But this plan means they have to defer life, make sacrifices with their money, and no doubt watch their friends move to better houses, take better holidays and drive nicer cars, while they scrimp and save and invest their money. Is this the best plan for them?
I would argue that it’s not. I would argue that the best thing for them to do would be to find ways of increasing the size of the capital that they have to invest each year.
Let me explain. If they could turn the £20,000 that they save each year into £60,000 within three years, and then invest that at 5%, they will achieve their desired passive income much quicker. If, after three years, each year they have £60,000 to invest for the long term, even if they simply put this money into a savings account that paid 5% interest, by tripling the amount invested, they will triple the passive income.
However, if they stuck this money into property, they would not only achieve 5% rental return, but in the long term would achieve capital appreciation and rental appreciation too. Better yet, if they leverage their money by buying the property with a mortgage, they stand to make significant gains in the amount of capital invested in the medium to long term.
They won’t be able to invest in any retail investment products that will turn £20,000 into £60,000 within three years, so they will have to seek alternatives. What are their options?
- Property development / Speculation
- Shares / Derivatives
- Businesses
- Land
There are no guarantees, but with enough knowledge of how these opportunities work, and if you do your homework you should be able to achieve significantly better returns than 5% year on year.
The secret to generating passive income quickly is first learning to generate capital. Once you’ve generated significant capital, you can create significant passive income. You can always do it the slow way, but ask yourself this question – do I really want to wait 25+ years to be financially free?
