While the term "passive" seems to indicate that there is no action required on the part of the investor - in reality, there is a lot of upfront work that is required. But once this upfront work is complete, there is only a nominal amount of ongoing work required - enough to make sure that the fundamentals of the investment have not changed (or that a better opportunity has not been presented to you).
If you wish to build long term wealth entirely through passive income sources, that is, without starting your own business or through active stock/bond trading, or by being a landlord or flipping properties, then you need two things in significant amounts:
- Capital, and
- Patience
Of course, the larger your current accumulated capital, the sooner you will reach your long term wealth and income goals. However, with the proper use of compounding and with sufficient time, passive income sources can comfortably and with considerably lower risk, develop serious wealth for you.
The Wealth Building System
The wealth building system presented here builds a pyramid of passive income sources that ensures diversification, and keeps risks very low even as the pyramid grows.
First, set up a goal for your target income level - let us say, $5000/month from your passive income portfolio. At an average return of 6%, this implies a capital requirement of $1 million. How do you get there?
At the first tier of your passive income sources, place:
Municipal Bond Funds are generally tax-free, though bond funds tend to have a fees associated with them. Overall though, you will come out farther ahead with this form of fund than a taxable account.
CDs are easy to open and close at your neighborhood bank branch or at a faraway bank - visit bankrate.com to find the best rates. TIPS & I-Bond protect your money against inflation, though the returns may not be very high.
Place your initial $50,000 into one or more of these vehicles, but begin sending the returns into tier 2 of passive income sources.
In the second tier, you begin introducing higher income producing vehicles such as:
These second-tier funds will generally preserve capital while generating a higher level of income. Build this to an additional $50,000 total, and then begin funneling returns to tier 3 of passive income sources.
At tier 3, begin introducing specialized closed end mutual funds such as
- Convertibles fund
- Debt Strategy
- Equity Income funds such as Dividend Stock fund
- Specialized Real Estate funds
- Floating Rate funds
At tier 3, you are seeking a couple of percentage point higher returns than tier 1 & even tier 2 - without putting the capital at significant risk. Take your time to do extensive research on these types of funds and then select multiple funds of different styles to provide the needed diversification.
And repeat, till your income goals are met. As you might reasonably expect, this method will act as a snowball, starting out slowly at first, but gaining in momentum and size as the years pass by. The first 5 years of saving will be really hard and slow, and this is where patience will be required. It is easy to get distracted and run after other, seemingly more lucrative (but higher risk) options. Staying the course is the name of the game here. The next 5 years will make you feel much better about your course, and the decade after that will accelerate you towards your final destination.