Even the richest people on earth adopt this strategy

Even the richest people on earth adopt this strategy

Blog #1 from our campaign "Financial tools' secrets" 

Making money while sitting from the comfort of your couch, the global dream… A dream that could be your reality depending on where you place your bets!

For many, money is a consumption tool – work, earn, spend, repeat. Passive investing has provided the ability for consumers to grow their hard-earned money by following the mantra “ if you can’t beat ‘em, join ‘em”. Even the richest man on earth has adopted this strategy – Jeff Bezos has 7 streams of passive income, making him wealthier by the minute!

Unlike actively investing, passive investing involves strategically placing your money in a mix of diversified assets and doing as little buying and selling of these assets as possible. This means that there is little to no liquidity in the investor portfolio, providing lower risk.

This laissez-faire approach follows the philosophy that, despite the markets undergoing downturns, it will inevitably rise over the long run. Another benefit linked to passive investing is that it involves lower costs due to fewer transaction fees and reduced management fees. Passive investing is perfect for those who are risk-averse and willing to wait for their returns.

This may seem to be a ‘lazy’ strategy towards growing your money, when, realistically, it is a thoughtful and time-honoured strategy, that aims to mirror the market in your portfolio – quite a challenging task! This means that it’s not only time that would be your greatest ally, but research. As stated by American entrepreneur, author and motivational speaker;

“Formal education will make you a living; self-education will make you a fortune.”

Give Musk a run for his money...

The question remains on what options are available to place your bets. The 4 types of passive income investments are;

1. Real Estate

Property remains the preferred choice for investors to earn long-term returns. According to CBRE UK Research, the real estate market is experiencing uncertainty in 2021, due to economic downturn brought about by COVID-19. Figure 1 below demonstrates the residential real estate market outlook for the next 3 years. Even with the rebound post-2021, weaker GDP growth and increased unemployment is anticipated to negatively impact the housing market. Provided, it is important to consider the economic backdrop and economic indicators (such as interest rates) prior to considering in these passive income instruments.

FIGURE 1: U.K. RESIDENTIAL CAPITAL VALUE AND RENT

2. Peer to Peer lending

P2P Funding, or crowdfunding is defined as the act of directly lending money to individuals/businesses, where the lenders and borrowers are connected via platforms such as Prosper and LendingClub. By cutting out the bank in the middle, investors earn a healthy return from principal and interest payments while helping others achieve their goals. Risk assessments are undergone through the application, however there are still concerns about high credit risks.

3. Dividend Stocks

When investing in companies on stock markets, some pay out a percentage of the earnings back to the shareholders. This typically occurs when a company earns more than management can effectively reinvest in the business, establishing a dividend policy and sending those excess profits back to investors is a smart move. The payout ratio, history of raises, steady revenue and earnings growth and a durable competitive advantage are the factors to consider when searching for dividend stocks to add to your portfolio.

4. Index Funds

These are types of mutual funds which holdings that mirror the market, or at least a portion of the market. Two consideration when comparing index funds is to ensure that the expense ratio (the funds directed toward administrative and operating costs) are low, and that there is a low tracking error (how far it fell from replicating the index).

Just a warning...

As most of us would know, money isn’t made without some risk or snags. Even when it comes to passive investing, there are some pitfalls:

1) There is no opportunity to beat the market. Unlike with active investing, passive investing doesn’t provide the opportunity to make money quick, fast and at higher market values. If you’re willing to settle for market, or below-market compensations, then this shouldn’t be too much of a damper.

2) The inability to react to market changes. When there are serious events that affect the market – positively or negatively – there is no ability for you to invest more or dis-invest to take advantage or to the risk in your investment. This may not be so detrimental to a younger investor who could wait out market crashes, but for those looking to utilise these investments as retirement funds in the near future… well, this could result in some serious repercussions.

3) The issue of the underlying investments… if a company that makes up a large portion of the fund turns out to perform poorly, the entire fund will do badly – with active investing this can be avoided by the active manager who decides not to invest in that company.

Getting the best bang for your buck

As the saying goes, don’t put all your eggs in one basket – a mantra when it comes to building your portfolio. Since there are pros and cons to active and passive funds, diverse portfolios often contain a mix of both, depending on the investment market/sector and the preference of the investor. This is the suggested approach when it comes to hedging your bets, especially when there is market uncertainty.

To decide on which investment option, if not both, is best for your portfolio, we will cover active funds in our upcoming blogs, so be sure to subscribe and keep your eyes peeled!

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