What is passive income?
Passive income is money that regularly goes into your bank account with little effort on your part, no matter how the market performs. Unlike growth investments, where you're hoping your wealth grows over time, passive income gives you a more stable cash return. Passive investing also will save you from worrying about market volatility and macroeconomic uncertainty, all of which could impact the performance of growth investments directly.
Some experts have called passive income an "infinite potential income stream1" because of the myriad of possibilities where you could generate this sort of income. Let's explore some examples of passive income you could consider for your investment portfolio, so you may receive steady returns, literally even while you sleep!
What kind of investments can help create passive income?
Now that you understand the fundamentals of passive investing, the next question you'll likely have is: what passive income ideas are there to explore? Passive income is usually generated from investments that carry lower volatility, such as dividend stocks, bonds / certificates of deposit and life insurance plans .
Revenue streams and income flow on these types of investments are relatively stable and more predictable as they're less volatile than other investments - they don't go up and down in price as much. This makes them a relatively stable part of your portfolio; you don't need to spend as much time monitoring them.
They're also more suited for long-term investing, so you don't face as much stress over having to 'time' the market accurately, buying when the price is at its absolute lowest and selling at the top. If you're the sort of person who really values peace of mind and who doesn't want to be kept awake at night worrying about market volatility, investments that generate passive income are likely to be a great fit for you.
Why is it good to start building passive income early?
1. You'll get a shot at achieving financial freedom
Passive income can come from investments that pay you dividends and interest you earn from your share holdings. For instance, if you've identified strong investments with dividends that grow by 15%, 20% or even 25% annually2, then the passive income generated from you staying the course longer term with these holdings is probably going to be more than sufficient to sustain your living expenses. That could give you the financial freedom you need to leave your day job or main source of income and pursue other personal dreams, if that's what you're aspiring to do.
2. Reap the benefits of compound interest
And speaking of these dividend or interest payouts? You can take these payouts in cash, but if you re-invest it instead, you can start to benefit from compound interest as well - a win-win situation for you.
Your new dividends and interest will be based on the new total, so every time you re-invest these funds, you may earn more interest and more dividends, allowing you to grow your portfolio balance.
Are there risks involved in building passive income?
Although passive income investments are less volatile, just like all investments, there's still a risk that you could lose the money you invest, or that you might not have the revenue stream you had expected.
There are many reasons for uncertain outcomes. A company you own shares in could be hit by a scandal that causes its stock price to plummet, political and social events happening all over the world could have an impact on the value of your investment, and even currency fluctuations could affect performance.
To manage risk optimally, don't put all your eggs in one basket. It's a good idea to consider putting your money towards a range of investments, in order to diversify your revenue streams. A good example is considering unit trusts, where you'll see your investment spread over a number of securities, instead of just one. That way, if you lose money on one, it could be balanced out by your other investments.
Another way you may mitigate investment risk is to consider including endowment plans in your portfolio. An endowment plan is a type of life insurance that is able to provide guaranteed returns (in the form of a lump sum payment) even over a short timeframe, and yet is less impacted by market volatility, so it's a great way to generate passive investment income for you, without requiring you to constantly worry over how the economy is performing. There are usually different maturity tenors attached to endowment plans, so you can choose the time period that suits your needs best.
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