Head of Partnerships
27 February 2019
“I want to make more money.”
“I wish I didn’t have to work so much.”
Most of us have likely said one of these sentences before, or at least heard variations of them. The common thread there is financial freedom: having the option to work part-time or maybe even not all. Working to achieve this freedom can motivate people to work hard and save in order to one day quit the rat race and enjoy more of what life has to offer. But there ways that don’t involve working extra hours, and that’s where passive income comes in.
Passive income generates income in the background of your life. It’s like having income on autopilot: you set up a system that generates income that doesn’t require consistent effort on your part, and isn’t part of your day job. You can think of it as an income stream that happens while you sleep, travel, and spend your time doing anything else.
There are plenty of ways to generate passive income. Depending on how much you plan, you can have a little extra income each month coming in, perhaps to cover your tax bill or utility bill, or you can generate enough passive income to sustain the same lifestyle you have without having to work a traditional day job at all.
Writing a book would generate royalties that could be passive income-- income that finds its way into your wallet while you’re sailing your boat in the Caribbean. But not all of us can write a bestseller. Fortunately, there are plenty of more accessible ways to generate passive income that easily cover some of life’s expenses and extravagances without the effort of a side hustle.
You can earn passive income by investing money in fixed deposit accounts. Fixed deposit accounts are a very liquid investment that generate interest. You can use the money for short-term expenses, such as your living expenses. Since fixed deposit accounts are liquid and less risky than other investments, they pay a very small amount of interest, e.g. under 0.5% (as of February 2019).
But, as you can probably imagine, generating any meaningful income from fixed deposits requires a large initial deposit: a $1,000,000 SGD investment at an interest rate of 0.5% produces just $5,000 SGD a year.
Singapore Savings Bonds are another low-risk passive income vehicle, and offer the safety of the Singapore government backing them. As of February 2019, they pay approximately 1.90% to 2.60% p.a.; where your returns fall in that range depends on how long you intend to hold the bonds. The longer the bond maturity date, the greater the return. The maximum holdings amount is $200,000 SGD. That means you could earn up to $5,200 p.a. on an investment of $200,000. This a great basis to generate some passive income, and could form a portion of your income stream.
In dividend investing, an investor buys what he or she expects will pay a regular dividend on a yearly, semi-annual or, less commonly, quarterly basis. The dividend rate, or “yield”, is the dividend amount as a percentage of the stock price, so how much yield you are getting is entirely dependent on your entry price. And, not only does the stock price vary, but companies can also decide to cut dividends in the face of undesirable company forecasts or economic conditions.
Take SingPost's dividend as an example of how much a stock price and dividend can fluctuate: if you bought the stock in 2014 at about $1.50 per share with a 4% dividend yield, today you would have lost more than 30% of your capital, as the share price dropped to $1.01 per share, and the company changed its dividend from $0.0625 to $0.035, so you end up with capital losses, a lower dividend rate, and a negative total return.
In short, if you invest in single stocks to earn income, you can face stock price volatility and dividend yield changes that you wouldn’t experience with a bond. So, when investing in a single stock to anticipate dividends, be sure to prepare yourself for potential large price swings and potential capital losses.
Alternatively, you can buy into an income portfolio that is professionally designed and managed to generate income on a regular basis. Given that these portfolios are managed by professionals, they traditionally can come with high fees. If the objective of the portfolio is to generate yields, and not a total return portfolio, portfolio managers may take more risk with your assets to achieve the yields. Note that this is not always the case, so be sure to ask how much risk your portfolio manager is willing to take with your money to earn your yields and returns.
Many people invest in real estate to rent it out and earn income from the renter. However, being a rental homeowner myself, I’d debate whether this strategy is really “passive”, given how much effort it can take if you don’t have a property manager. And if you do have a property manager, the management of the rental takes out a significant chunk of time and becomes an active “full-time” job. This is a perfect example of how passive and additional income streams range in the levels of engagement and profitability.
Want to buy real estate but don’t want to pay a property manager or put the time and effort into managing additional properties? You can buy into REITs, which are pooled funds that own commercial real estate, as an alternative to owning and managing physical property. REITs aim to grow the investments while simultaneously producing income for its investors. Having REITs is a good way to diversify your assets.
Just as your investment portfolio should be diversified across asset classes, so should your ways of generating income. Setting up income streams not only allows you to buy or save more, but it can also serve as a good Plan B: you should avoid relying on a single form of income (i.e. ‘Plan A’), as that can cause trouble if your normal income stream suddenly changes due to medical reasons or job loss, for example.
I hope that the above ideas spur you to get started on your road to financial freedom. There are plenty more ways to diversify your income stream and put your money to work. Ultimately, your passive income strategy should reflect your personal preferences and priorities. Do some research, and ask around to discover how you can make passive income and live with more financial freedom and financial security.