How Passive Is Your Passive Income?
I’ve been lumping in my online income with my passive income, but it isn’t really passive. It may not be very strenuous and it gives me geographic flexibility and I don’t have to show up for work every day, but there is some effort involved. Unfortunately I’m not as clever as Courtney Tuttle, who says he has a site that makes $3,500/month with no ongoing maintance. I’ve just had some limited success with Domain Parking, buts that the extent of my truly passive online income.
Simply put, my online income isn’t really passive. It’s a lot more passive than the website and seo consulting work I do by a huge margin, but its not as passive as dividneds or royalty checks.
So what are the best ways to earn really Passive Income?
1. High Dividend Stocks
There are a lot of stocks that paying quarterly or yearly dividends. Over time, the power of compounding (with a little help from inflation) can substantially increase the value of your dividends. My mother bought the Indian subsidiary of Unilever (Ticker: UL) called Hindustan Lever about 20 years ago. She’s being reinvesting most of her dividends and today her annual dividends are larger than the value of the original stock purchase. American Capital Strategies (ticker: ACAS) has been growing its dividends approximately 10% every year. According to The Dividend Investor,
If we invested $100,000 in ACAS on December 31, 1997 we would have bought 6906 shares. Your first quarterly check would have been $1,726.50 in March 1998. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend payment would have risen to $17,095 by December 2007. For a period of 10 years, the quarterly dividend has increased by 300 %. If you reinvested it though, your quarterly dividend income would have increased by 890%.
Yes, reinvesting the dividends in companies that have historically kept increasing their dividends is key. Even though you might get only 2.5% return today, eventually with the increase in stock price and rise in dividends, your annual return should be greater than 12%. This concept is very well explained in Prof. Jeremy Siegel’s excellent book, The Future for Investors, which I highly recommend.
2. Oil & Gas Royalties
While there is a lot of fraud and speculation in direct oil drilling programs, they can be very, very lucrative for investors. Charlie Munger invested about a $1,000 in such an oil drilling program in the 60s and he’s estimated that its paid out over $500,000 in royalty payments since then. Apparently it still pays out $2,000 a month. Of course, most people NEVER see these sort of returns, but for the average person, investing in Canadian Oil & Gas Royalty Funds (or Income Trusts) is the next best thing. I’ve invested quite a bit of money into both the direct oil wells and the Canadian Income Trusts (or Canroys) and the overall result has been pretty positive in both (which is in excess of 12%).
3. Royalties on Books and Patents
Royalties on Books and Intellectual Property Rights can be even more lucrative. However writing a best-selling book or creating a something thats worth patenting can extremely time consuming and expensive. For most authors and inventors, its a labor of love - something that they would pursue even if there was no monetary reward to it. But many ebook writers who sell get-rich-quick books about “making money online” are getting very wealthy. Most of these books are garbage and the only people getting rich are their authors and resellers. Not a very ethical way to make money.
4. Rental Income on Properties Bought at the Bottom of a Real Estate Cycle.
If you bought rental buy and hold property in California, Nevada, Arizona or Florida during 2005 and 2007, my heart goes out to you. A lot of smart people got suckered into buying at the top of the market and are paying for it. However, if you buy correctly, preferably at the bottom of a real estate cycle, real estate can provide excellent passive income and fantastic tax advantages as well. According to Charlie Munger at the 2008 Wesco Financial Annual Shareholder meeting, “most real estate investors don’t pay any income tax, except once every 20 years or so“. Bought correctly (that is based on value, not speculation), rental properties can provide a steady stream of cashflow that is somewhat inflation-indexed. I say somewhat, because in the short-term anything can happen, but over a long period of time, real estate is going to match the rate of inflation.
5. Investing In Timber
Similar to Canroys, there are companies that grow trees specifically for timber and pay pretty decent dividends. There are also direct tree-planting programs where you can invest a minimum of $5,000 and own a portion of a timber operation. The company does all the work for you and supposedly cuts you a check once a year after a specific time interval. The endowment funds of Harvard and Yale have apparently been investing in timber for several years now with great returns.
6. Domain Parking (or Embarking)
There are many people who buy and hold hundreds of domains (I know a guy who owns 750). They either park them with Sedo or another domain-parking service. These services stick relevant (and sometimes not-so-relevant) ads on your site. The idea is that if someone comes to the site through browser type-in traffic and clicks on an ad, you get paid a portion of this ad revenue. I had hosted several sites with Sedo and made a whopping 2 cents per month. I’ve recently been trying out a new service called Domain Embarking that is working pretty well for me.
If you found this post helpful, consider donating to my coffee fund!Popularity: 15% [?]
[All content is copyright of Living Off Dividends & Passive Income]
Related Posts
You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
May 18th, 2008 at 12:16 pm
These are all good sources of passive income. To expand on this, I would recommend REITs. They are lot easier to buy and sell than actual property, in other words, more liquid and may also reduce risk.
In addition to books and patents, another source for royalties is music - write a catchy tune and collect cash every time it’s played.
May 19th, 2008 at 2:08 am
Nice post. I guess I would throw CDs into the list as well, although they aren’t paying very much these days. I use the word “passive” as well on my blog, but most of the money that I am bringing in outside my day-to-day job takes considerable time. I sometimes refer to it as “supplemental” income instead. Take my loans on Prosper - I spend several hours a week searching and bidding on loans that don’t always get funded. So far in 2008, I have made just under $42 in interest on 35 loans - not very passive.
May 19th, 2008 at 10:17 am
What Are The Best Ways To Earn Passive Income | LIVING OFF DIVIDENDS & PASSIVE INCOME…
What are your sources of passive income?…
May 19th, 2008 at 12:49 pm
Living Off Dividends,
Thanks a lot for the link. I do agree with you that buying a diversified mix of dividend producing stocks is the closest to passive income as possible.
Best Regards,
Dividend Growth Investor
May 20th, 2008 at 6:03 am
I’d like to know how I can avoid paying income taxes due to having a rental property. The smartest tax people I know can’t seem to figure it out.
May 21st, 2008 at 3:33 am
[…] How Passive Is Your Passive Income? posted at LIVING OFF DIVIDENDS & PASSIVE INCOME — Points out that blogging is not really passive income (yes, there’s a lot of work involved), and shares some of the best passive income sources. Packing your lunch to work could save you upward of $30 per week. Since food that you prepare yourself tends to be healthier, there’s also a long-term health benefits. […]
May 21st, 2008 at 5:09 am
Lazy Man,
I am no tax expert, however the only way you can avoid paying taxes in this situation in my opinion is if your income is less that your expenditures.
May 21st, 2008 at 6:44 am
..[Living Off Dividends asked his readers How Passive Is Your Passive Income?. He even quoted my analysis of ACAS there]..
May 21st, 2008 at 10:42 am
that sounds about right. are they renting as individuals or a business? are they claiming interest on mortgages, maintenance, and all that kind of stuff?
May 21st, 2008 at 2:00 pm
Good, sound advice here. I absolutely love seeing my monthly and quarterly dividends coming in even when I’m not doing anything but holding the stock/fund! Especially in troubling economic times like these, I’ll gladly take my bond funds and their 7-8% yields any day.
May 21st, 2008 at 3:18 pm
Excellent read! I have long decided that blogging is NOT passive, otherwise i am doing something VERY wrong!
@Lazy Man and Money: I am not expert, but my understanding is for most rentals the depreciation is greater than the income generated. You just need to remember to die before it is sold at a huge gain.
Best Wishes,
D4L
May 21st, 2008 at 4:18 pm
Hi,
I really enjoy reading your posts and I learn a lot from you.
Thank You.
Jamy
May 21st, 2008 at 5:02 pm
[…] What are the best ways to earn passive income? - Living off Dividends enlightens us about four types of truly passive income. Via the Money Hacks Carnival. […]
May 22nd, 2008 at 5:34 am
These are all great ideas. Expanding on the books/ebooks, they don’t necessarily have to be best sellers to produce a nice stream of passive income. An increasing number of experienced professionals are turning their work into self-study programs for their niche audience. Yes, it will take time initially but it doesn’t take much money to produce it.
May 22nd, 2008 at 11:04 pm
Ok, here are the 3 things currently that I have in large sum for passive income:
1. AUD. Aussie rate is currently at 7.25% so imaging the interest rate on CD.
2. High yield (i.e. junk) bond fund. Risky but rewarding (dividend-wise).
3. GNMA fund. Only risk is NAV fluctuation. Dividend is better than Treasurys but you don’t have to worry about 1) default and 2) recession. However, this will be an issue with hyperinflation.
May 23rd, 2008 at 3:17 am
I remembered GG (goldcorp) used to give out dividend every month but when I first bought, I did not go for the dividend but I go for their good management&cores and I foresee it will go up in the future, I bought it around $4+ in 2003 and now it is $40+. It is a challenge for me to really go for stock that yield dividend cos I often wonder up/down of the stock price vs. dividend . Can anyone share their thoughts with me about that ?
So, it is a challenge for me to go for dividend.
Other passive income like blog adv., rental etc are more of my liking.
Jamy
May 26th, 2008 at 6:22 am
I prefer REIT’s to owning actual real estate. For most of my landlord friends, their income is anything but passive.
One investor has about 150 apartments. He is continuously painting, fixing, addressing calls about overflowed toilets, contracting for replacement carpet, etc. It is a full time job.
With my REIT, I NEVER get a call about an overflowed toilet. Bliss. I just collect my income. And the REIT sends me a 1099 that tells me how much is taxable and how much is return of capital (depreciation), etc. So I have hardly any bookkeeping either.
Wait, it gets better. Some REITS have options. So in addition to collecting my income, I can also write covered calls on them. It’s not unusual for me to collect ongoing income around 15% of money invested. And if the REIT goes up and is called away from me . . . damn! I was just forced to sell it at a profit (in addition to all the income I collected prior to the forced profitable sale). No problem. Then I write cash covered calls until it comes back down in price. In the meantime, I’m still making good money.
REIT: Passive. Real estate: Lots of work.
May 26th, 2008 at 6:26 am
Err. I write cash covered puts until it comes back down in price.
Sorry for the typo/confusion.
May 27th, 2008 at 3:28 am
Leopold - I use this strategy for several stocks in my portfolio. Got any suggestions on REITS you care to offer?
May 30th, 2008 at 3:03 am
[…] A great - and recurring - question is this: How passive is your passive income? […]
May 31st, 2008 at 6:53 am
A for instance has been HCN (Health Care REIT). I chose it for the relative stability of medical rentals, the stable dividend, etc. It’s a worthwhile buy just for the dividend and business prospects. My cost on it is $39. It had been hovering between $40 and $45 for a long time, and I kept writing calls at $45. My call income exceeded my dividend income.
Right now, my June calls will likely call the stock away from me at $45. Damn, I collected a 16.2% annualized return. And NOW I’ll be “forced” to sell the REIT for thousands of dollars in profit.
Options in HCN are thinly traded with large bid-ask spreads. This particular puppy probably won’t provide sufficient put writing income, so I’ll likely not write puts on this one. I won’t buy it at $48 and write calls at $50, so I’m off to something new right now.
BMY (Bristol-Myers) looks like it will have some play for the next year. But their research pipeline looks like it becomes bare in about 2 years. I’ll want to be out about a year ahead of that. Most people don’t worry 2 years ahead, but things could get dicey from about 9 months out.
I set up a trade in March that got me a nice return. I’ll be called out of the stock this June, but collected a quarterly dividend and a nice profit on the call. BMY is something I could write puts on for sufficient income. If it drops down, I own it again at a reasonable price. If it doesn’t, then I still collected good income.
BMY has dropped a LOT in the past 2 years, but it’s current 5% dividend and $20 psychological barrier give it good support at $20. I’ve been known to be wrong . . . I cringe when I think of those times, but over-all I do just fine.
May 31st, 2008 at 7:06 am
Discipline is key to my investment returns. The small amount of time I spend on it is fun for me, so quite passive in my book. I use a trading plan, and I find that most really successful investors use a trading plan. I present my (simplified) trading plan for everyone’s benefit.
Leopold’s Trading Plan
1. General.
a. A maximum of 5% (or portfolio value) can be invested in any one vehicle. A vehicle is either a single stock choice, any bond choice from a company, or an option strategy executed on a particular stock or index. More than 10% may be invested in government bonds or money market funds. Mutual funds may be up to 20%.
b. Strategies that I have not tested or do not have experience with should be limited to a maximum of 5%.
c. It is preferable to mitigate margin borrowing. A temporary margin to trade from one position to another is perfectly acceptable. Margin cash to back up option positions is OK (not margin borrowing).
2. Stocks.
a. Dividends.
i. Must be 3% or more.
ii. Secure.
iii. If dividend is cut or likely to be cut, exit trade.
b. Optionable stocks are preferred.
c. Stocks between $20 and $60 are preferred. No stocks below $5 shall be traded. Stocks over $80 are frowned upon unless it is part of an index trade.
d. I shall follow and know well the stocks I trade. I prefer to limit these to 20 stocks or fewer.
3. Options.
a. I trade theta positive strategies.
b. I master a few strategies and repeat them over and over. These strategies currently comprise my repertoire.
i. Covered call writing.
ii. Cash covered puts.
iii. Bull put spreads.
iv. Bear call spreads.
v. And by default . . . Iron Condors.
My trading plan consists of more, but I thought it would be helpful to people to see how a passive income investor actually structures his trading. Hope this helps someone.
June 19th, 2008 at 10:02 am
I don’t have any truly passive income streams….