Save until it hurts each month
A common mistake most people make is thinking that they are saving enough through their retirement funds, but the stark reality is that you are not. Creating passive income will require you to aggressively invest your after tax income each month. Most retirement accounts don’t allow you to draw from your pre-tax accounts before the age of 59 and a half withouth taking a 10% penalty.
In order to enjoy financial freedom in the future, you will have to sacrifice some of the pleasures you are enjoying today. Ask yourself the question, is that Starbucks coffee really worth it? Do you need to go on this expensive holiday or can you do a staycation instead? What will happen if I don’t buy this expensive hand bag or pair of shoes?
Focus on income-producing assets
If you want to be able to earn a reliable income the day you leave your job, the key is to invest in income streams that will allow you to survive. Investing in dividend generating stocks, certificates of deposit, government Treasury bonds, corporate bonds and real estate are good examples of investments that will generate passive income. There are a lot of other attractive stocks out there that will provide capital growth, but not necessarily provide income.
An easy way of generating semi-passive income is buying a rental property. This will provide you with a tangible asset and could provide a reliable income. Buying a rental property does come with issues like maintenance and having to deal with tenants.
Start as soon as possible
Since the 1980s interest rates has been largely declining, tremendously increasing the amount of time required to build a passive income stream on which you can retire. A 5% plus return on short term cash deposits in a savings account is something of the past. The best you can hope for today is a 12 month cash deposit savings account of 2.5%, while the best money market account will give you 1.85%. This means for every $100 you save you will generate a passive income of $2.50.
As most of us don’t want to work 70 hours a week at our jobs, having to deal with constant stress, we have to start looking to save. Try saving every second paycheck, or every bonus you might earn. This will start adding up and generate a passive income.
Calculate how much passive income you need.
Having a passive income goal is very important to keep you motivated. A good goal could be to try and generate enough passive income to cover your basic living expenses such as food, shelter, transportation and clothing. If you are spending $30,000 per year on these expenses, then divide that figure by your expected rate of return. This will tell you the amount of capital that you will need to save. Don’t forget that you will have to pay taxes on this income so you will have to multiply your capital amount by a further 1.25 to 1.5.
$30,000 divided by 3% is equal to $1 million in capital required that will generate $30,000 of passive income for you before taxes. Since you need to account for taxes, you will need to have somewhere between $1.25 million and $1.5 million to generate $30,000 in passive income after tax when you have a 3% rate of return.
Make sure you are properly diversified
Capital preservation is underrated. We saw a lost decade for tech stocks between 2000 and 2010 after the first dot-com bubble burst. It actually took 13 years for Nasdaq investors to get back to even. Investors in the Borsa Istanbul stock market index just gave up 10 years’ worth of gains after they saw a plunge in their currency, partially due to increased tariffs by the US and a lack of confidence in the government. Your passive income needs to be properly diversified in order to take the hits.
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