Passive Income Strategies part 2

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In this second part of our passive income strategies we look at some more ideas

@ponsulak via Twenty20

High-Yield CDs

Investing in a high-yield certificate of deposit allows you to take advantage of some of the highest interest rates in the country in order to generate a nice passive income stream.

First, you’ll want to do a Google search of your country’s top CD rates and check out the interest rates.

You’ll probably want to use an online bank to get that top rate. So long as that bank is backed by the FDIC, your principal investment is protected (up to $250,000).

The only real risk with high-yield CDs is rising inflation, but at the moment, that doesn’t look like much of a threat. Keep an eye on the market and you can easily avoid that risk in the future.

Invest in an REIT

This stands for Real Estate Investment Trust and it’s just a fancy term for any company that owns and handles real estate. They usually own and/or manage commercial properties (either the physical property or the mortgage on that property). They tend to focus on a specific group of properties, like medical care or shopping centers or hotels

An REIT is like a stock share. They’re structured so that they pay little or no income tax so long as they pass most of their earnings along to their shareholders. You buy an REIT just like any other stock on the market and earn dividends several times a year as with other high-yield dividend stocks.

Retail REITS (shopping malls and freestanding retail businesses) account for about 24% of investments in America – that’s the biggest investment by type in the country. When you’re thinking about investing in an REIT, you need to look at the whole retail industry. Is it healthy and likely to stay so – or are things looking rocky

Remember the REIT firm is getting their income from the rent of its tenants, so if you’ve got a shopping center or business that’s got a high turnover rate, it’s probably not going to generate as much income as you’d like.

You might think about aiming at traditionally “safer” real estate investments like grocery or home improvement stores. Keep in mind, also, that a lot of shopping is shifting to online. That shopping mall may not even be in existence in ten or twenty years.

There are also residential REITs, which focus on apartment buildings and manufactured housing.

With this type of REIT, you’ll want to look at location. For example, the best apartment markets are where there are less homes available, like in large urban centers. The largest residential REITS tend to focus on areas like this.

You should also look at population and job growth. As long as the apartment supply in your market stays low and demand is increasing, your residential REIT should perform well.

Healthcare REITS invest in the real estate of hospitals, medical centers, nursing facilities and retirement homes. This is probably going to be one of the investment areas to watch as our Baby Boomers grow older and require more skilled care.

However, remember that the success of the REIT is tied to the healthcare system. So long as the healthcare funding remains questionable, so do these REITs. Look for companies with a lot of healthcare experience.

There are also office REITs who handle office rentals. There are 4 basic questions you want to ask when investing in this area:

  • How high is the unemployment rate?
  • What are their vacancy rates like?
  • What’s the economy like in the area you’ll be investing in?
  • How much capital does the REIT have?

 

Think of investing in “economic strongholds.” In other words, it’s better to have a bunch of average office buildings in DC than to have primo space in Detroit.

Dividends from a good REIT can even increase yearly, so you might just end up with a growing stream of dividends over time.

There’s a bit of research involved with this stream, as with any stock purchase. You want to be sure to pick the best REITs that will increase your earnings instead of dropping in value. You’ll also need that initial outlay of cash to get the ball rolling.

One way to minimize your risk is to buy into an Exchange-Traded Fund (ETF) than diversifies by investing in lots of different REITs instead of sinking everything into just one individual trust. These often have lower risk ratios so you can gain exposure to real estate trading without as much risk as investing in an individual company.

You do need to do your homework with an REIT or ETF. Even though it’s considered passive income, you can lose big if you choose the wrong ones. You’ll want to start analyzing these companies like you did for the regular stocks. It takes a bit of time and effort before you can pick out the best choices.

A tough economy can take a big bite out of your income stream as well. If your REIT doesn’t create enough income, it might reduce the dividend or cut it out entirely. That could be disastrous because a tough economy is just when you’ll need that passive income coming in.

 

Build a Bond Ladder

This is a portfolio of fixed-income bonds that mature over a period of years at different times. This lets you decrease your reinvestment risk by minimizing your exposure to fluctuating interest rates.

Let’s say you buy a five-year bond at a fixed interest rate – but two years from now, interest rates go up. Your bond is still chugging away at that lower rate and there’s no way to change it.

However, if you have different maturation rates, you might be able to roll over some of your bonds and take advantage of that better rate. You can take the same amount of initial investment and stagger your maturation times so you’re more likely to be able to profit from the market.

Another example: you purchase a 2-year bond and get a 1% yield on that. You also purchase a 4-year bond for 2% yield, a 6-year bond for 2.5% yield, and an 8-year bond with 3% yield. In two years, when the first bond matures, you reinvest the proceeds in a new 8-year bond with 3% yield – and continue this practice as your bonds mature (assuming interest rates stay the same or increase, of course).

Charles Schwab of https://www.schwab.com  suggests buying a minimum of ten securities for diversification. The idea is to take the total amount you’re planning to invest, with the goal being to extend your ladder as long as possible. He suggests a minimum of $100,000 to be invested with ten rungs of $10,000 each.

One benefit to having at least six rungs is that you can easily build a ladder that will generate monthly income, since each bond will pay out twice a year. You’ll also want to consider the spacing between rungs. The longer the ladder, the higher your income is likely to be, since those are the bonds that will give you higher yields. Of course, going long tends to increase your risk, as we discussed above. You may reduce your income a bit by buying shorter-maturing bonds, but it’ll be safer in the long run.

Just like a physical ladder, you build this one with different material. In this case, different types of bonds or CDs. As each one matures, you just reinvest the principal in new bonds with the longest term you originally chose for your ladder. If interest rates go up, you can reinvest at higher rates; if they go down, you’ll still have some bonds locked in at a higher rate to fall back on.

Bond ladders do come with risks, of course, such as the interest rate may fall. And since bonds are not backed by the federal government (like corporate bonds), you might lose your principal

And just like stocks and REITs, you’ll want to own many different bonds to diversify your risk. You can find a bond ETF just like an REIT ETF, that will give you a portfolio of bonds you can build a ladder from. This will greatly decrease your risk of a single bond hurting your returns.

 

Rent Your Free Space

You’re probably not actually using that spare bedroom for anything other than storage, right? Why not fix the room up a bit and rent it out?

It just takes a bit of time and effort to clean and de-clutter the space. You can advertise on lots of different websites like Airbnb or Zillow and set the rental terms yourself.

If you rent to a longer-term tenant, you’ll be collecting a check with minimal extra effort on your part. Short term tenants bring risks we’ll talk about in a minute, that you might want to stay away from.

In fact, nowadays your rental space doesn’t even have to be a room. You can put up a tent in your backyard and rent a camping experience if you live in a scenic area. You can rent the whole backyard for a party space if you’ve got it decorated and have a barbecue pit and/or a pool. People will stay almost anywhere if it’s interesting enough.

The first step is to check out the local laws. Call your housing authority or check out the local government website to find information about renting a room in your area. Your home owner’s association may have additional laws regarding rental as well, so check with them before you advertise.

Many city ordinances require renters to have access to clean running water and working plumbing. Some cities require a room to have windows large enough to be used as a fire escape – or even to have outdoor access. You’ll need to check the laws before you rent.

Check out the fair housing laws at the US Department of Housing and Urban Development (HUD), too. You’ll need to create a tenant screening criteria form which will protect you if someone decides to file a discrimination claim against you. This lists everything to keep in mind when considering a prospective tenant. It’s a little more work, but it may help you avoid a hefty legal fee. You can find free examples of this form online.

Once you make sure you’re legally allowed to rent a room in your home, check your homeowner’s insurance to make sure it’s approved. Some companies don’t have a problem, but others won’t allow it – and some will raise your rates if you rent.

Tenants increase your liability and risk of property damage, so you might even have to get landlord insurance (which costs 15-20% more than homeowner’s insurance).

Check comparable rental rates in your area to find out how much rent you can reasonably charge. You can use https://www.rentometer.com/  to check this out.

Using a service like https://www.spareroom.com  or https://www.roomster.com can help find a compatible tenant for your space.

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