Passive income does not require a lot of your energy or time, yet your bank account continues to grow fatter every so often. Investment income, copyright income, patent income, leases, mining rights can be said to be passive because they involve a onetime big effort then later on very minimum involvement is required. In this guide, you learn how to make this kind of income, literally from scratch.
As a first step, understand the language used in investment circles so you can intelligently communicate with your new circle of investment moguls. Investment lingo include terms like investing, which means committing your money in an investment vehicle, hoping to make a profit, where vehicles include bonds or debt, stock or shares, mutual funds, real estate, unit trusts and businesses. The income earned could be interest, rent, dividends, royalties and capital appreciation on sale etc.
Before you plunge into the deep end, you must have a concrete reason why you are investing because it will guide your choice of investments and act as a compass when market conditions change and toss you new risks and opportunities.
Even if we finished college same day and were employed earning same salary, our financial situation can never be identical, even over a short period of time. This is because our specific financial environments which include background, lifestyle, age, responsibilities and opportunities to earn or spend money vary greatly, day in day out. For example, it is highly unlikely for both of us to have a medical emergency that requires Kes100k at the same.
Noting this peculiarity in financial situations, our reasons for investing will always be different. We largely invest to achieve three things; earn income, enjoy capital appreciation and or safeguard our wealth.
A man approaching retirement will invest to safeguard his assets while a young professional will be interested in current income to finance a lifestyle and or long term capital appreciation. The young investor has more time to make up for losses he might incur along the away, while the retiree must get it right. A millionaire will not worry much putting Kes0.5m in a speculative asset while a struggling starting out couple will shy away from this, opting a safer low capital low return investment instead. These factors determine your risk tolerance which eventually determine your choice of investment vehicle.
Below are some major vehicles that promise to earn extra income on your capital.
Bonds refer to fixed income securities premised on debt. When you buy a bond, you are lending government or the corporate entity that issued the bond. The risk is relatively low and when lend to a stable government it is risk free, hence expect lower returns.
Stocks accord you the right to own part of a company and receive dividends and or bear losses as allocated by the company. The income from stocks is highly variable, varying from day today. Compared to bonds, equities apart from providing variable incomes, also provide capital appreciation or depreciation in form of an increase or reduction in the market value of the shares.
Mutual funds are a collection of stocks and bonds and entails pooling resources with other investors which is then invested and professionally managed by the fund manager.
For seasoned investors, other investments include businesses, options, Exchange Traded Funds, offshore funds, Futures, Forex, Gold, Real estate etc, which are discussed in detail elsewhere on our www.financialmatters.co.ke website.
Once you know the vehicles that you can invest in, you need to establish how much money you should commit to achieve your financial goals, noting your current expenditure, and your earnings potential. You must continue living now as you invest for your future, hence a budget is your starting point.
Next, how are you practically going to go about investing in the vehicles that you have chosen. Are you going to do it alone, walking to the stock exchange or are you going to hire a broker, or a financial consultant? Note the costs vary with each choice. Costs associated with investment include brokerage fees, commissions, stamp duty, withholding taxes etc.
You now know the investment vehicles, you know the costs associated with each type of brokerage, you know your risk tolerance and you have a financial objective to achieve. It is time to choose the investments to go for.
By getting some bonds, some shares and some real estate or business, you create a unique portfolio which has unique characteristics depending on the percentage mix of each. If you choose a portfolio with a higher percentage of equity, it becomes an aggressive portfolio because it seeks higher returns and assumes higher risks and is suitable for high risk tolerance individuals, young and highly liquid.
A portfolio with more bond percentage is referred to as conservative and is suitable for risk averse individuals with short time horizons for returns, for example retirees.
In between an aggressive and a conservative portfolio is the moderately aggressive portfolio, for individuals with a moderate risk appetite, e.g. young career individuals.
Once you have chosen your investments and their time horizons, it is now time to manage yourself. It is said that investors lose money not because the markets moved to their disadvantage, but because they were unable to control their emotions and act rationally.
As hard as it is to see market forces barter your portfolio positively or negatively, endeavor to remain grounded and maintain your strategy.
The portfolio that you have just created will help you diversify your risk. To earn maximum returns, the bulk of your money should be in the highest earning category within your risk tolerance. This requires careful periodic review and re-balancing if required.
Investing is a personal endeavor which guarantees you extra income or the only income during your retirement. There is no one size fit all solution. Explore as many alternatives and keep re-jigging and re-tweaking your portfolio to maximize on returns, while minimizing your risk.