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Income Investing: How to Generate Cash Now

October 16, 2020 by Lazy Man 5 Comments

If you are looking to make income by investing your money you are not alone. For the 73rd straight year, our savings account is earning an interest rate of zero. Yours are probably doing the same. The Federal Reserve has dropped the Federal Funds Rate to 0.25%, which in layman terms means that you aren’t getting paid much interest in your savings accounts. Fortunately, this also means that some of your loans may be charging less interest.

Over the last couple of weeks, I’ve been talking a good friend of mine who is a little older than me… kind of like a big sister. We think alike on many things. In some ways it is almost like talking to myself, but a “me” with ten years of more life experience.

Lately, we’ve been focusing on investments to create income. We’re both in a fortunate situation where income is steady despite COVID-19. Since we aren’t traveling, going to restaurants, or buying much gas for our cars our spending is way down. That leaves us with a little more money to invest than we’d normally have.

At the same time, the stock market continues to be near new highs. I’m worried that stocks are priced too high, especially when corporate profits are likely to be so low. Many, many people seem to be worried about that. For this reason, I’m looking for investments that tend to be safer. I’ll return to my usual growth investing when the pricing is better. In the meantime, I’ll continue to stay invested, but stay conservative.

Many people moving into their 30s and 40s find that they have more responsibilities (i.e. children). It makes sense to have investments that generate income. That income can be used to supplement your salary now or to help phase out your job in the future.

If you could generate $50,000 in cash from investments, you could probably retire, right? Of course, your answer depends on your spending, assumes no inflation, and has a bunch of other messy details.

So in this world of (close-to) zero interest rates, how do you generate income?

Income Investing: How to Generate Cash Now?

This is a refresh of an article from 2015. While I have been talking with my big sister about this topic again, I also participated in this this Twitter conversation with Financial Pilgrimage. Specifically, he asked, “Where can you invest your money passively these days for a 3% return or greater besides stocks?”

I don’t want to discount stocks because they are a viable option… perhaps the most viable option. Let’s start there and branch out.

Dividend Stocks for Income

For most of my investing life, I never looked at dividends. I forgot that people once bought stocks to create income. Companies would pay out profits to shareholders and shareholders could use that money, to… well… buy stuff they need. It was a good little system. I speak of it in the past tense because many companies stopped paying dividends and instead kept the money to grow profits and raise their stock prices. In reality, dividend investing didn’t go away, I was just too wrapped up in tech stocks (which rarely pay dividends) and index investing (set it and forget it) philosophies.

In 2020, I’ve focused more on dividends. I like the idea of companies paying me money even if the stock market is crashing. I’ve mentioned that I’m managing stock market risk and removing tech risk from my portfolio with dividends. Specifically, I’m buying iShare’s high dividend ETF (Symbol: HDV). It has many big companies that you’ve heard of. It also pays a dividend of more than 4%.

Another thing that I like about dividends is that they are very tax efficient. Qualified dividends can be taxed at 0% at reasonably high-income brackets (~$75,000 for joint filers). If you make less than $400,000 qualified dividends are taxed at 15% a year. (This is overly simplistic for the scope of this article. Please see your tax professional for more information and advice.)

Unfortunately, due to COVID-19, corporate profits have dropped. Some companies can no longer afford to pay the same dividends they did in the past. That’s why I like the ETF approach. It spreads that risk over a lot of companies.

If you want to take a more hands-on approach for potentially bigger gains, you could look at making passive income with dividend kings. If you prefer to get higher dividend gains without hours of research, I recommend Sure Dividend’s newsletter. That link to the newsletter has a special discount rate and in full disclosure, I make a few dollars if you sign up for it.

Find a Strategic Investment Balance

The credit for this idea goes to my aforementioned big sister. She had mentioned that she was looking at the Vanguard LifeStrategy Income Fund (Symbol: VASIX). It’s a conservative blend of 20% stocks and 80% bonds. Historically, it doesn’t go up or down a lot. Since it was created in 1994 it has had annual returns of 6.26%. It’s 1-yr, 3-yr, 5-yr, and 10-yr returns are all between 4.95% and 6.82%, which gives you an idea of how consistent it is. During the big stock market crash of 2008, it lost about 15% of its value. That’s very good when traditional stock investments lost 50% of their value.

This could be an option to park some medium-term money that you may use in 2-4 years. I’m interested in this because it achieves my goal of staying invested, while still providing some protection in the case of a big market crash.

Income from Real Estate Investment Trusts (REITS)

This is really a special case of the dividend stocks above. However, the profits are generated by real estate – which can move in a very different direction than the rest of the stock market. REITS are traded as stocks and have to pay 90% of its taxable income as dividends to shareholders. The end result is that you can earn 4-7% in dividends. However, like a stock, their value can go up and down.

My favorite way to buy REITS is with Vanguard Real Estate ETF (Symbol: VNQ). It’s easy one-stop shopping with a company, Vanguard, that I trust.

Getting Income from P2P Loans

In the past, I’ve recommended P2P loans. They haven’t worked out as well as I have expected. A few days ago the top P2P loan company, Lending Club, announced that it closing down its lending platform.

I had been steadily pulling my money out of Prosper and Lending Club for the past few years. Prosper is still around and it may be a good fit for getting a passive 3%+ return on your money.

Skip Income Investing: Pay Down Your Mortgage Instead

One of the readers of the Twitter thread mentioned an obvious way of getting 3% for many people… paying off a mortgage. That’s a guaranteed return on your money, which may be valuable to you.

I’ve been against this for years because I’ve always felt that I can make 8-10% by investing in the stock market. Over the long run that has worked out exactly as planned. However, his stock market feels different and I’m not sure what has happened in the past is going to continue for the next 10 years.

I’ve mentioned over the last few weeks that we are doing a 1031 exchange – selling one real estate property and buying another one. Because we formed a corporation, the bank is charging us a 4% interest rate. Not only that, but it readjusts every 5 years – it could be 7% or more in 2020. I didn’t know this when we went down the 1031 exchange path. Now, I’m much more interested in paying down this mortgage quickly.

The downside of paying down your mortgage is that you are effectively locking yourself into that 3% (or whatever your interest rate is) return for the long term. Also, in this case, you aren’t creating investment income. Instead, you are reducing debt, which, while different, can be effectively the same.

Get a High Interest Savings Account

Derek of Life and My Finances mentioned that Lake Michigan Credit Union has a 3% Max Checking account.

I didn’t like the requirements of direct deposit, 10 debit card purchases a month and 4 logins to their website. The direct deposit it a one-time change with your work, which hopefully isn’t too difficult. Derek mentioned that using services like Mint and Personal Capital count towards the logins. That leaves 10 debit card purchases a month. If you are still buying coffee shop or Starbucks each day, this may be easy.

For me, making the 10 debit card deposits would be difficult. I also know that I would forget or not be able to keep track of for several months of the year.

Final Thoughts on Income Investing

I think the best plan is to combine multiple of the above suggestions. A portfolio of 35% HDV, 35% VASIX, 10% VNQ should provide some long-term hopefully, safe gains. The remaining 20% of your money could be used to pay down a mortgage and invest in a high-interest savings account.

This wouldn’t survive a big market crash and still make 3%, however, it would probably not lose too much and put you in a position to make 5-6% most years.

This article was originally published on Mar 2, 2015 at 10:45

Filed Under: Investing Tagged With: dividends, income, mortgage, P2P, REITs

Real Estate vs. REITs

September 23, 2013 by Lazy Man 16 Comments

Six years ago, I wrote an article comparing stocks vs. real estate, using a Money Magazine article as a base. Few of my articles stay in memory too long, but this one did. I remembered it being one of my better articles. Unfortunately, in re-reading it, the writing was, well, terrible. There were parts of the article that I can’t even follow today.

Today, I’d like to revisit the topic. Perhaps being a few years wiser will translate to a better article. (If it doesn’t, then heaven help me.)

Over a month ago, I wrote about expanding our real estate empire. In a comment, Evan from My Journey to Millions, made a great point, “I go back and forth on the real estate investment option. On the one hand it seems to be the clearest way to wealth, while on the other it seems almost crazy to take on that headache for a few hundred bucks of current income. Have you given much thought to REITs instead?”

For those who aren’t familiar with REITs, they are Real Estate Investment Trusts. You can buy shares of REITs just like stocks or mutual funds and collect a share of the profits. Typically they pay high dividends making them good for those looking to build an income portfolio. Also, because they are usually diversified amongst a number of properties, risk is minimized. I’m a strong proponent of them and believe that putting 10% of your portfolio into an ETF like Vanguard’s REIT index, VNQ is a good diversification strategy.

So if I can invest in real estate without dealing with tenant headaches, I should right? Well, it’s all about the numbers.

A Typical Return on REITs

Zack’s Research notes that “During the 40-year period from 1972 to 2012, average annual total returns for REITs were 8.09%…” Given that information, I feel comfortable using an 8% estimated return on REITs in general.

For sake of argument we’ll presume that you have $23,000 to invest. Yes, it is an odd number, but you’ll see why I chose it in a couple of minutes. In 15 years, $23,000 invested at 8% turns into $72,960 (don’t we all love compound interest?). Why am I looking at 15 years? Again I ask you to humor me for a few minutes. At that point, $72,960 would give you $2,918 in income using the rule of 4%. That rule of 4% says that you can roughly take out 4% of your invested money safely to live on retirement.

To sum up the last paragraph, a $23,000 investment now in REITs will give me nearly $3,000 per year in income in 15 years.

I realize that there are loads of assumptions here from the expected return on a REIT to the rule of 4% (some say it’s closer to 3%). Unfortunately we have to make some assumptions for this exercise and hopefully these are “reasonable” assumptions given the information cited.

The Return on My Investment Property

Last week, we closed on the investment property we were looking for (hold the applause). The agreed price was $95,000. With closing costs, we ended up writing about $23,000 in checks (you should be having an “a-ha” moment). We financed the rest with a 15 year fixed mortgage.

With mortgage, condo fees, property taxes, and insurance it will cost us $1025 a month. We are very confident it will rent at $1250. For sake of argument, let’s presume that the $225/month ($2700 a year) “profit” will go towards maintenance and real estate listing fees. That’s actually almost scary accurate as estimated maintenance is typically 1% of the purchase price. So that’s $950 in maintenance, plus $1250 (one month’s rent) a year.

So for sake of argument, the $23,000 is going to be invested for 15 years (another “a-ha” moment?). At that point, we’ll collect $15,000 in rent and owe condo fees, taxes, insurance, maintenance and listing fees. The condo fees are a big hit, but that’s very much part of the maintenance as I explained in this article. By the time all those costs are added up, we should be clearing $10,000 a year.

So to sum up this section, a $23,000 investment now in this property will give me $10,000 per year in income in 15 years.

(In fact, in the extremely unlikelihood that the property doesn’t appreciate at all in 15 years, the $95,000 property will still be worth more than the REIT investment. For what it’s worth, 8 years ago the property was estimated to be worth $185,000.)

Real Estate is Even Better

Hopefully at this point, you see the wisdom in dealing with troublesome tenants. We don’t need the AT&T guy interviewing a bunch of kids to tell us that $10,000 is better than “nearly $3,000”, right? So how could it possibly get any better?

The “nearly $3,000” in income from REITs is money in 2028 dollars, which will probably buy you less than it does today. The $10,000 that I’m using is assuming today’s rent of $1250. In reality, in 2028 it would rent for $2250 assuming 4% inflation. The math then comes to 27,000 where I’ll pay $8K-$9K in the condo fees, taxes, insurance, etc. and come away with $18-19K in 2028 dollars.

In 2028, do I want to have “nearly $3,000” or $18-19K a year? I think I’ll go with the later.

Real Estate is not all Rainbows and Puppies

Real estate comes with its headaches, no doubt about that. A REIT has never called me up in the middle of the night with a plumbing problem. Additionally, if there’s a problem and you need access to cash, it’s fairly easy to sell a REIT. Good luck selling a piece real estate in an emergency. You’ll get pennies on the dollar and take around a 6% hit on commissions from real estate agents. In addition, there are few things less diversified than buying a single property. If the economy in that town takes a nose dive, my property value, and the ability to rent it, takes a nose dive with it.

Finally, the condo complex, having been built in 1985 is just starting to show wear and tear today. What it is going to look like in 2045 when it is 60 years old? It’s probably going to look like properties from the 1950’s today… no bueno.

What’s your take? Let me know in the comments.

Filed Under: Investing, Real Estate Tagged With: REITs

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