Welcome to Let’s Talk Money Monday! “The New 7 Income Streams of Millionaires,” written in collaboration with Justin Castelli of RL Wealth Management, is a three-week series to give you ideas, tips, and strategies for creating the financially-free life you dream of. Each week, we’ll take you through a specific type of income stream and give you some examples of how you might integrate it into your life. In the end, this is about you. Pick and choose the income-generating activities that fit your life and your goals, and run from there! And remember: start where you can (even if that’s 3 income streams) – Rome wasn’t built in a day, and your financial freedom won’t be either. But, stick with these strategies and, over time, you’ll end up with a life you intentionally designed. So let’s get started! This week, we’re talking about how to make your money work FOR you with portfolio income!
Portfolio income streams will take even more patience than the active income streams and passive income streams we’ve already discussed. Before we take a closer look at portfolio income, we need to stress the importance of making sure your short term savings needs are adequate before you start building the foundation for your portfolio income source. The capital allocated to portfolio income should not be needed for a number of years, for reasons we will discuss shortly. If you don’t have your emergency fund fully funded, portfolio income needs to be delayed until you do.
As we mentioned in our first post in the series, portfolio income is income built from capital gains, dividends, royalties and interest from loans. The most common way to build portfolio income is through investments in stocks and bonds, either directly, or through investment vehicles like mutual funds and exchange traded funds (ETFs). Portfolio income will likely be the most difficult thing for you to leverage early on in your career. And this is understandable – if you don’t yet have a ton of capital to invest into various types of financial instruments, how can you make your money work for you on a larger scale? However, portfolio income streams are crucial to get a handle of – and potentially work with a professional partner on – so you can use them as strategically as possible as your nest egg grows.
Let’s first define some principles for building portfolio income, then we can take a closer look at different vehicles to build the portfolio, and finally, we’ll talk about how your portfolio can generate an income…
Start allocating dollars to your portfolio income stream sooner, rather than later. When it comes to building a portfolio to generate income, time is your friend. The longer your portfolio has to grow, the better. Compound interest is one of the most powerful forces in the universe. Don’t believe me? Well, Albert Einstein coined that phrase.
Let me give you an example of the exponential growth provided through compound interest. If you fold a piece of paper in half 42 times, it will reach the moon. Although it’s technically impossible to fold a piece of paper in half 42 times, the exponential growth that would take it to the moon is the same phenomenon turns $10,000 into $1,000,000, given enough time.
While active income streams and passive income streams can yield immediate returns, portfolio income will take some time to build. So, while you are building your other income streams, make sure you are saving and building the foundation for your portfolio income in order to let the power of compounding work for you.
Compound Interest Part II.
The capital you have sitting in a bank account is going to need more time than you have to reach a level of compounding that yields any sort of income…there’s just not enough growth in your savings account. In order to help your portfolio grow, you will need to take on some risk. You should be willing to do this because the reward for taking on risk is higher returns over time. The higher the expected return of your portfolio, the faster your capital will grow, and the greater the income.
To give you an example of how investing can help your capital grow, let’s look at the power of compounding and the Rule of 72. The Rule of 72 represents a quick approach to determining how often your capital will double: if you take 72 and divide it by the expected return of your portfolio (ex: 7%), the quotient (answer) is the number of years it will take for your capital to double. So, if the expected return of your portfolio was 7% a year, you could expect your capital to double about every 10 years.
The Rule of 72 is not a guarantee; rather, it’s a rule. There are other factors that could prevent your capital from doubling in the time found using the rule. But, the Rule of 72 shows the need for investing to grow your portfolio. To determine how to structure your portfolio, you should consult a financial professional, preferably a CERTIFIED FINANCIAL PLANNER® professional. Investing involves risk, and it is important to make sure you develop an investment strategy appropriate for your risk tolerance and that is in line with your goals. A professional can help you do both.
Pick your investment.
As I touched on in Compound Interest Part II, the higher the expected return, the quicker your portfolio might grow (“might”–nothing in investing is guaranteed). In a bonus week for this series we will discuss the different types of investments that might be used to build your portfolio. We’ll talk about:
- Stocks and Bonds
- Mutual Funds
- Private Investments
Keep costs low.
When choosing the investments to include in your portfolio (listed above and detailed next week), it is important to take into consideration the expense of the investment. There are low cost investments (such as ETFs and Index mutual funds), and there are expensive investments (like commissionable mutual funds and annuities). The expenses associated with investments typically come directly from the investments, thereby lowering your net returns. This means expensive investments create a drag on your portfolio’s growth and on its ability to generate income. Information regarding investment expenses is readily accessible on a number of websites, or you can consult a financial professional–it’s probably wise to do both.
Regardless of how you decide to construct your portfolio, you should diversify your capital across different asset classes. There’s the old saying, “don’t pull all of your eggs in the same basket.” Same applies with your money. The chart below illustrates the value of diversification:
Once again, consult a financial professional to help construct a properly diversified portfolio.
Leverage reinvesting, until the portfolio income is needed.
While your portfolio grows, you will have the opportunity to receive the dividends and capital gains in the form of cash, or you can have these distributions reinvested back into the funds. Note: There are some instances where dividends cannot be reinvested. When your dividends and capital gains distributions are reinvested, they are simply used to buy more shares of the investments you own. The reinvestment of dividends and capital gains has been shown to increase portfolio growth. So, if you don’t need the distributions for income, reinvest them. You can decide to collect them in the future as a source of additional income, but in the meantime, let them grow!
Befriend a Roth IRA.
Although we are discussing building portfolio income to supplement your current income, I would be remiss if I did not stress the importance of starting your retirement savings early (for all of the reasons we’ve reviewed above). If eligible, a Roth IRA may be a great option to begin building your retirement nest egg. A Roth IRA is a tax-favored vehicle that is contributed to using after-tax contributions. If certain conditions are met, the distributions in the future are tax-free. There are certain income limitations and strategies to contribute to a Roth IRA, so we’ll direct you once again to a financial professional to discuss if a Roth IRA makes sense for you. But at the very least, make sure you are aware of the Roth IRA.
Read and educate yourself on investing.
Once you begin building your portfolio, continue to read and educate yourself on the investments you own, along with other options. Never stop learning! This is one of the best ways to make sure you stay on top of your portfolio activity.
Now that you’re up to date on what portfolio income is and why it should play a role in your overall income stream strategy, what’s next? Well, SURPRISE! We have a bonus round next week! Meet us back here next week as we get super practical and learn more about the different options available to structure your portfolio income.
If you’re curious about what joining the YouEconomy looks like, think residual incomes sound like the bomb.com, or would like to create a plan for building up your active income streams, reach out to Ashton at firstname.lastname@example.org or via the Contact page!
Disclaimer: This post is for educational purposes. Nothing in this blog should be considered advice, recommendations, or a solicitation to buy or sell securities. If you have questions pertaining your individual situation you should consult your financial advisor. For all of the disclaimers, please see RL Wealth Management’s disclaimers page.