Passive Income Know Your Options – Snowball Effect
If you are striving for Financial Independence like myself, you are always thinking of ways to cut expenses and create a passive income stream. I am just like you, right now I am cutting expenses while I am on my Ragnar Lothbrok plan of attacking my personal debt. While I am attacking debt with the crazy aggression and tactics of a warrior put against the enemy, I am also working on creating passive income. In a perfect scenario the goal is to be debt free and take any extra income you earn and create passive income with your investment of choice. I’m not perfect and I’m guessing you are not either. Most who read my blog have a mortgage, student loan, car loan, or credit card balance to name a few. If you are reading this you have started the journey to Financial Freedom, you are cutting expenses, paying off big 96oz steak size debt, and working your way to create passive income. Let’s talk about Passive Income baby, let’s talk about you and me, let’s talk about all the good things and the bad things that may be let’s talk about Passive Income(Name that song, Twitter shout out for the winner) and now let’s get to know the most common paths to financial independence.
- Stock Market Investment Capitalization aka Save and Grow. This sounds more difficult than it actually is, simply said this is you saving money and putting the proceeds into the stock market to watch it grow and grow and grow. Let’s put together an example and because I like it simple(KISS aka Keep it Simple Steven) we will be using 50K as our average annual salary our take home pay after taxes and insurance and such. If you are saving 50% of your income(Great Job, You are a Rockstar) you are saving 25K and putting this towards your Financial Independent Snowball, which is piling higher and higher as you keep adding 50% of your savings each year to make your investments grow and grow and grow into a massive avalanche sized snowball. If you are on this path and assume a 5% rate of return you are able to retire in 17 years. Here is one of the classic posts by Mr. Money Mustache that explains the ins and outs of this a little more. You are saving 50% of your income, the next step to is to find what investment vehicle(401K, IRA, Taxable) you would like to choose based on how you want your investment to be taxed today and in the future, very important. That decision is more technical in nature and depends on your own situation; the Mad Fientist has been my go to for the technical side of things. The most important piece of this puzzle is the end when your investments are increasing at a rate that is equal or greater than your expenses. In this scenario you will have about 25K-30K in return each year coming in to cover your expenses and still have somewhere between $600,000-$700,000 in total investments, this talk gets into the 4% withdrawal rate, which I will not discuss remember I’m not the technical guy in this situation. Long winded answer is save a bunch of money 50% or more, put it in the stock market, and watch it grow, assuming our 5% rate of return you will be riding your Magical FI Snowball all the way to the Passive Income bank.
- Dividend Investment Return. This is a combination of our above stock market investment capitalization and receiving a dividend from your stock purchase. In this scenario we are still are still using our large savings rate of 50% to invest our money into the stock market, but here we do not care about the 5% investment return(we care, but it’s more of a bonus), instead we are banking on receiving a dividend for each individual share of stock. When your dividend income is greater than your expenses you are considered financially independent. Alright example time! I will use Even Steven’s Dividend Diva Corp(the company is made up, shocking I know), every quarter decides to pay it’s investor’s $.25 per share, if you own 1 share of stock you will then receive $1 annually just for owning Even Steven’s Dividend Diva Corp. The idea behind the dividend investor is that they care less about the overall stock market return of 5% mentioned from above and more about a continuing solid dividend investment history and return. The end goal of dividend investors is to live off the income from the dividends once this amount is greater than your expenses you will be cashing dividend checks like Grandma thinks your birthday is every month and continues to send that $5 check, thanks Grandma you are the best! Very similar to above you are creating your Financial Independent Snowball, first you have $1 in dividends, but as you purchase more shares your dividends increase and in many cases the dividend payout increases as well, CHA-CHING(that’s a cash register sound if you are under the age of 25). I’m very intrigued by using this as one of my passive income streams, plus who doesn’t love getting checks deposited to your account each month? Crazy people that’s who.
- Real Estate Investment Income. This passive income approach has more variables in it but contains one passive income path that I am more familiar with. I am going to stick with the most conservative approach of real estate investing and one we have chosen, owner occupied investment real estate. The strategy behind the rental income is to have a tenant pay for your mortgage over the life of the loan. Assuming you have a 100K property at a 6% interest rate and you are receiving $600 in monthly rental income which is equal to your mortgage payment of $600. So you are going to be breaking even,I will also assume that the rent you receive covers everything just to make this calculation simple. If you do not pay any extra on this 30 year fixed loan you will pay this off in the normal 30 year length of the loan. We are striving for financial independence, not 30 years of mortgage payments, I present to you the Super Baller Financial Independence Snowball. We are taking the $600 from rental income and then Super Baller Snowballing our expected mortgage payment from our own salary, $600 Renter, $600 from Even Steven. While it seemed like we were previously breaking even with our $600 income from the renters, we made the Super Baller decision of doubling up our payments! In this scenario the snowball has 2 affects: 1) It allows us to pay off the home in 9 years and 1 month(I didn’t even mention rent increases every year, take that inflation) 2) It has the Double Effect. What does that mean exactly? Well your expenses were (-$600) at the beginning, but by paying off your rental property, you are now at a positive +$600 in 9 years, that’s a change of $1,200(not including rental increases). This is exactly why real estate in my mind is my favorite investment for FI and creating wealth. Yes there are taxes involved, but I’m going to leave that up to a tax professional, but for the most part owning a home especially since it is owner occupied is going to save you money in taxes.
There you have it make sure you know your options to create passive income and keep rolling that snowball until he becomes a Super Baller FI Snowball!