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! In this BONUS week, we’re getting super practical and talking about specific investment instruments that can help make your money work FOR you!
Before we jump into this week’s *bonus* round, make sure to catch up on the entire series!
Got it? Okay, good.
Now that you understand each of the three streams and have bought into the principles of building your portfolio income, let’s take a look at the different investment options available to structure your portfolio income.
Stocks and Bonds.
Stocks and bonds are investments in individual companies and governments. A stock represents ownership in the profits and losses of the company. A bond is essentially an IOU from the company or government; you give your principal to the company, they pay you a set interest rate over a period of time, and you receive your principal back at the end of the term.
Typically, stocks are invested in with the goal of growing the initial investment, and bonds are invested in with the goal of generating a predictable income.
A portfolio of individual stocks and bonds tends to be riskier than some of the other investment options we discuss below. The single largest limiting factor to building a stock and bond portfolio is capital…specifically having enough capital to buy into enough companies in order to spread risk around.
Main Considerations for stocks and bonds:
- Company risk. Building your portfolio income using a handful of individual stocks and bonds is tough, and it will require you to know the companies and their risks inside and out.
- Default risk. If you are using bonds to generate portfolio income, your main risk is default risk. In other words, will the company/country be able to pay your principal back at the end of the term, or will they default on their obligations?
- Lack of diversification. As mentioned, diversification is an important aspect of portfolio construction. However, to be properly diversified, a significant amount of capital is necessary. Read below for some other more efficient options.
- Buy/sell rules. Should you decide to move forward using stocks and bonds, consider following strict rules for when you will buy and sell. Investing can become emotional, and having a list of rules to help guide your investing can be helpful in overcoming your emotions. Consider having a price at which you will sell if the stock price falls (in order to limit losses), as well as setting a price at which to cash out and take gains. It won’t be easy, but having rules will help.
- Continued monitoring. Because you may only be able to start your portfolio with a few individual stocks or bonds, you will need to stay on top of the companies. Stock prices can move quickly! This continued monitoring will take time, so be prepared to allocate some of your schedule to monitor to your portfolio.
If you’ve participated in your company 401(k) or already have an IRA, you are probably familiar with mutual funds. A mutual fund is a type of investment where the dollars of the investors are pooled together to make investments in individual stocks and bonds (aka securities). The shareholders participate in the gains and losses of the underlying securities. Mutual funds are designed to be held for longer periods of time. In fact, there are actually rules to prevent investors from trading them.
The advantages of mutual funds are that they provide a broad diversification amongst hundreds of securities, they are easily accessible, there are relatively low requirements of capital to get started, there are a variety of options in terms of active and passively managed funds, and it is easy to reinvest dividends.
Main considerations for mutual funds:
- Expenses. You need to understand how much your investment will cost, and why. Expenses can include both internal management fees and commissions, if applicable.
- Turnover. Turnover refers to the frequency of the buying and selling of the underlying securities. This is important because of the potential tax implications that will be passed on to investors.
- Active vs passive. Active mutual funds have a team of investment managers attempting to pick the underlying securities in an effort to beat the markets. Passive mutual funds do not attempt to pick underlying securities. Instead, they hold the indexes–you are basically getting the market with no opportunity to outperform. Evidence suggests the higher cost of an active mutual fund typically does not beat the market, which would favor using passive mutual funds. To determine which is best for you, consult a financial advisor.
- Style, sector and location. When investing, there are different styles that can be implemented. For example, a mutual fund can be focused on growth stocks (called Growth Investing), or on cheap stocks (called Value Investing). Each has advantages that should be considered when building a portfolio. In addition to considering style, you should also consider what type of companies the mutual fund invests in (technology, financials, etc.) and where the fund invests (U.S., International, etc.).
Exchange Traded Funds (ETFs).
ETFs are highly similar to mutual funds. The main differences between the two can be seen in the structure of the funds, how they are traded, and the associated costs. While the two act similarly, the structure of mutual funds is that they pool shareholders’ dollars together, whereas ETF investors actually own the underlying securities of the ETF. Mutual funds are also different in that they trade at the end of the day, while ETFs can be traded throughout the day (more like stocks). Finally, in terms of cost, ETFs tend to be much cheaper than mutual funds because of their structure and the their tendency to passively track indexes. Naturally, as the ETF market continues to mature, more active ETFs are being introduced.
The main advantages of ETFs are that they have lower expenses, are more tax-efficient, are more liquid, and they have the ability to be very specific with investing (ex: there is a Social Media ETF that only invests in social media companies).
The things to take into consideration while looking at ETFs are very similar to mutual funds…so take a look above for a refresher 😉
However, one additional consideration is that you need to pay special attention to what you are investing in. Some ETFs use leverage (without getting into too much detail, leverage amplifies any gains and losses) – which is really designed more for traders. Unfortunately, I’ve seen too many newbie investors holding leveraged ETFs without being aware of the additional risk they include.
The investment options above are the most common and accessible options to build your portfolio in a way that brings you portfolio income. While it makes sense to start with the basics, as your portfolio grows, you can look to other options like:
- Peer-to-peer lending (P2P)
- Private Investments
- Angel Investing
When you get to this stage of investing, consulting a financial advisor is necessary.
Putting It All Together
Now that all of our definitions and considerations are out of the way, we can finally talk about how your portfolio can start to generate income…maybe not today, but down the road.
Two ways to generate portfolio income:
Capital gains and dividend distribution.
The mutual funds/ETFs/stock/bonds that you (and your financial advisor) decide to use to build your portfolio will generate income from the dividends and capital gains distributed. In a prior post, we discussed reinvesting dividends and capital gains. But when your portfolio gets large enough, these distributions can actually be paid out to you, thereby generating a new income stream. By only taking the income distributed by the portfolio, the principal of your portfolio has a better chance at lasting since you are not using your capital. However, over time, it is possible for dividend distributions to be reduced by the funds in your portfolio. In this situation, your portfolio income may go down.
You can also generate income using a planned selling strategy. A planned selling strategy involves selling pieces of your portfolio to generate income. There are different approaches that can be used. For example, one strategy could involve only selling when the portfolio experiences a predetermined gain. In this example, only investment gains are used for income.
Another strategy could involve selling a set amount at scheduled times regardless of investment growth (or loss). It should go without saying, but a planned selling strategy can increase the chance of your portfolio becoming depleted. If the growth on the portfolio does not keep up with the distributions, you will see your principal begin to dwindle. Note: Because of the tax implications of buying and selling investments, not only should a financial advisor be consulted, but so should a tax professional.
Depending on the strategy, or combination of strategies, you choose, the amount needed for your portfolio will vary. It’s not a hard number to arrive at once you have determined the income you would like to generate from your portfolio and the strategy you will use. For example, if your goal is to generate $1,000 a month from your portfolio generating a 2% yield from dividends, $600,000 would need to be accumulated. This is a generic example not including tax implications; the goal is to illustrate how much might need to be saved under a yield-only income strategy.
The ultimate goal is to save and invest to grow your portfolio to a level that will generate the income you need to supplement your other income streams. Portfolio income takes time to build, but with discipline and the tolerance to see your account balance fluctuate, investing is the best way to help grow your capital. With a proper investment strategy and income plan, your portfolio will have an opportunity to provide an income for years to come.
What are your 7 streams?
With all of this in mind as an outline, you can assess your current situation, decide what makes the most sense for you in terms of time and capital required, and start building your playbook of income streams. And, likely sooner than you think, you’ll start to feel the abundance of money flowing to you through multiple sources.
Curious to know – which options presented above are most attractive to you? What’s one thing that’s holding you back from getting started? And, what’s one thing you can do THIS WEEK to start building up the number of income streams you have flowing in? Let us know in the comments!
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.