- Date : 03/10/2020
- Read: 5 mins
The right investment choices can help generate passive income even while you sleep!
The need for passive income sources has never been more pronounced than now during the ‘Black Swan’ COVID-19 pandemic. Amid the fear and ambiguity surrounding job security and pay cuts, many families are trying to reduce their expenditure, focus on saving more, and use their time to either upskill or to develop a passive income stream.
What is passive income?
Passive income is a source of extra money earned either through a business or investment plan that consistently generates a side income with minimal long-term effort and maintenance. The primary idea of earning passive income revolves around the concept that you should be able to make money even while you sleep.
With active income, your skill, time, and effort directly translate into revenue or salary. For whatever reason, if you are unable to work or incapacitated due to illness, injury or an external event like COVID-19, you could lose your ability to earn money. Passive income, on the other hand, is not dependent on your everyday effort. It allows you to minimise the financial uncertainty of the future and pursue your time doing things that you love, rather than chase a pay cheque every month.
How can one build a passive income stream?
Just as a sapling has to be nurtured and protected for years before it becomes a fruit-bearing tree, building an ‘automatic’ source of income takes a considerable amount of time, effort, and patience in the beginning. While there are many ways to hustle and generate passive income, one of the smart passive income ideas is to focus on making your money work for you – via investments.
Savings and investments deployed across income-generating avenues can help you compound your wealth without having to actively manage or adjust your portfolio. However, there are some key factors you need to take stock of before you can zero in on investment-related passive income ideas. Let’s see what they are:
Maximising your savings: You need money to make money. The more you are able to save today, the quicker you will be able to attain your passive income goals. You may have to make some financial sacrifices in the short term to fast-track the process. The earlier you start saving, the quicker you will be able to reap the benefits of your investments.
Calculating your income needs: For complete financial independence, you must generate enough passive income to take care of living expenses such as rent/ maintenance, groceries, travel, medical needs, etc. Make a backward calculation to estimate the savings required to manage your expenses. Calculate your annual expenses and divide it by the expected average rate of returns from your investments.
For example, if your annual living expenses amount to Rs 5,00,000 and your expected return on investments is 8%, you will need a corpus of Rs 5,00,000/8 = Rs 62,50,000. The actual amount required could be higher depending on the returns generated by various investments, and after accounting for taxes and inflation.
What investment options can be considered?
Investing for the purpose of generating passive income is different than saving for other life goals. The investment options have to be selected after carefully considering their ability to generate a steady income with minimal risk to your capital investment. Here are some income avenues to consider:
- Interest income: Fixed income investments such as bank deposits, post office savings, government bonds, etc. generate interest income that can be withdrawn on a quarterly basis. There is low risk associated with these investments; however, the returns too are not substantial given the current economic scenario. Most debt options offer interest rates between 4% and 8% before tax.
- Dividend income: Dividend income can be generated either through direct equity investments (high dividend stocks) or mutual funds (index funds/ large-cap funds). Dividend yields will vary from one investment to another. Hence, it is important to check the track record of the company/fund over the previous 5–10 years to get a fair idea of the performance.
- Rental income: Investment in a ready-to-use residential or commercial rental property is another great way to generate passive income while the capital investment simultaneously appreciates. Residential properties in most Indian cities yield anywhere between 2% and 4%, while rent on commercial properties can go as high as 8%. However, real estate requires a significantly larger investment and the asset has to be carefully selected based on the locality and maintenance cost.
Consult a financial advisor to understand which are the best investments for your needs and risk appetite. Younger investors can opt for a higher equity allocation (up to 50%) while older investors with higher disposable incomes can consider real estate and fixed income securities.
Diversifying your investments is important to spread risk and manage liquidity. While rental income can be received monthly, interest income is usually credited quarterly and dividend income may come in only once a year. Therefore, you will have to plan and stagger your investments accordingly. Read to know more about how you can clean up your investment portfolio.
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.