Late last year I shared a post with you guys on increasing the GYFG household income to $600,000 annually, and in that post there were two concerns that I said I wanted to start addressing in 2017:
- Concentration Risk – In 2016, approximately $27,000 of the $340,000 that we earned came from passive sources (or about 8%). The majority of the income we brought in was from our day jobs.
- Tax Efficiency – The other problem outside of the concentration risk, is that with earned income, we are taking a beating when it comes to taxes. As we all know, earned income is not the most tax efficient, and based on our 2017 projected income our marginal tax rate federally is going to be 33% and 10% for state (this is on top of FICA, Medicare, and CA SUI/SDI).
In order to address both of these issues, I have decided that it is finally time to start focusing on building up our passive income sources. As a first step, I have put together two new tabs in my master Excel spreadsheet, one will help me keep track of our dividend portfolio, and the other will help me keep track of all of our passive income sources.
I am a big believer of the saying “in order to know where you’re going, you have to know where you’ve been.” So, let’s take a look at the current state of our passive income as of December 2016.
Current Passive Income Streams
To be honest, after I finished pulling all this together, I was actually pleasantly surprised to see where our baseline was. A gross amount of ~$27,000/year is a respectable amount, yet we still have a long road ahead of us to get to $120,000/year.
Why $120,000?
We have been tracking our expenses in detail for 3 years now (2014 to 2016), and our annual spending has landed in a range of $110,000 to $120,000. Keep in mind that this does include the cost of the mortgage for our rental, our home mortgage, and costs for home improvement projects (only a few projects left; we tackle one a year). All of which we plan to eliminate from our budget all together over the next 5 years.
Eliminating those 3 expenses, will free up ~$48,000/year, which we will then re-allocate to other spending categories, one of which will likely be travel. All of this to say, that $120,000 should give us a very large cushion above and beyond our annual cost of basic living (defined by our own standards).
Let’s not pass over the fact that eliminating expenses is also another form of creating what I like to refer to as phantom passive income.
Filling The Gap From $27,000 to $120,000
Back to business.
We currently have an additional $93,000 of passive income to create and there are so many options to choose from in order to reach our goal. Let’s take a look at how much additional capital we will need to put to work at different yields in order to quantify how much we will need to invest:
3% Yield= $3,100,000 – This is probably pretty easy to achieve by constructing a stock dividend portfolio. This will mostly be focused on in our retirement accounts.
5% Yield = $1,860,000 – This could be accomplished with the right mix of corporate bonds or even in rental real estate here in California. I have actually run some numbers based on our primary residence and this is about the cash on cash return we could expect to earn currently if we turned our place into a rental.
8% Yield= $1,163,000 – My new favorite asset class is in the debt portion of the real estate equity stack. Also known as hard money lending. Through PeerStreet I have found the ability to access this market at scale and with diversification and huge downside protection. This is an asset class I have already put $77,000 to work in 2017 (over about 43 investments).
15% Yield= $620,000 – I have seen others online achieve 15% + cash on cash returns investing in out of state rental real estate. Not going to find this in my home state of California. Although this is very alluring, my wife and I are really growing fond of the online platforms. At some point we will be ready to take on some more leverage, the timing just isn’t right for us yet.
This list is obviously not exhaustive, but it is the spectrum of yields and investments we intend to pursue in order to build up to our income goal. My gut says if we set this up correctly, we will likely end up investing about $2,000,000 in order to fill our gap (representing a 6% blended yield).
As a result of this new focus I will be periodically sharing a detailed breakdown of our passive income sources, like the table above.
What sources of passive income do you have? Do you have a goal that you are shooting for? What of some other ideas you can share to generate higher yields?
– Gen Y Finance Guy
33 Responses
Although our passive income goal is lower than yours, it’s interesting that we’re both about 22% of our way to our targets. Of course, I am from Gen X, so you are way ahead of me in terms of the ages we will be when we finally get to our goals!
I agree with your numbers. Although dividend stocks and bonds are what I am most comfortable with, it will take a lot of capital to reach my passive income target using those alone. I’ve had a small amount in Lending Club, and am very interested in checking our Peer Street based on your thoughts. Thanks for sharing that information!
ROMT – Thanks for the comment. 22% of the way to your passive income goal is great. Are you going to stick to stocks and bonds? Or do you plan to allocate a meaningful amount of capital to other asset classes like real estate?
I don’t feel so bad now with our $80k early-retirement budget. I see bloggers (like Mr Money Mustache, but others too) showing how they can live on under $50k/year and I wonder just how wasteful I’m being. But hey – worked hard to reach this point so why not enjoy it, right? As long as the needed income falls within the reasonable/safe withdraw rates for our investment levels – should be good! Thanks for sharing your own budget goal.
Hey Brad – To each his own! We all have our own ideal life and if MMM and others can make that happen with less money, then more power to them.
Hi Dom, your number isn’t much different from us. We plan to retire early and need to be conservative in our estimates and have plenty of cushion.
We get our passive income primarily from stock index funds but also have a good chunk of money in a small business my brothers and I own.
I know you’ve shot for $10 million net worth before. Does this analysis change your mind to something south of that? We have targeted the $3 million net worth as our baseline.
TGS – I think it really boils down to the difference between Financial Independence and Financial Freedom. I have always known that I wouldn’t need $10M to retire early, but that also hasn’t really been the goal to date. I do agree that at around $3M we will have officially reached Financial Independence.
As it stands right now, I don’t have any intention to stop chasing my $10M goal.
BTW, it has been interesting reading about the business you own and the potential opportunities for expansion.
Cheers!
Good for you Dom. The beauty is each additional million is much easier than the prior.
Thanks Dom, glad you’ve enjoyed reading about my small business! I’ll keep the updates coming.
I love the idea of focusing on the passive income. It’s crucial to plan for your annual living expenses so you know what threshold you have to reach to cover expenses. We’re still getting out of debt, but I can’t wait until we get to the wealth-building part of our journey.
Mrs. Picky Pincher – You know what they say “you have to learn to walk before you can run”.
You guys will be out of debt soon enough. Just keep your eye on the finish line.
Thanks for laying all of this out. You mention tax efficiency in the beginning of the article but how do you plan on tackling this tricky topic? Are you thinking California municipal bonds? Something more tax efficient today and then moving to that money to passive income streams later? The problem with these passive income streams when your income is already at $600K is that those passive streams will be taxed at your high marginal rate today. Looking forward to seeing more as this plan develops.
Hey Josh – I didn’t really touch on the tax efficiency part did I?
I land at the same conclusion almost every time I look at this tax challenge, Real Estate! The fact that you can depreciate the property over 27.5 years. Take the house we currently live in, assume we turn it into a rental. We bought the house for $370,000 (of which about $60,000 is for land), which means we have $310,000 of depreciation over 27.5 years, giving us $11,272/year in non-cash expenses to write off against rental income. On top of this the mortgage (with property taxes, insurance, and HOA) runs $1,850/month or $22,200/year in additional expenses to write off against the rental income.
Currently, I believe we could collect $2,500 to $3,000 a month in rent for our house. Let’s use $2,500 on the conservative side, which gives us $30,000/year in rental income (before any property management or repairs). We will ignore repairs for the moment and assume $1,200/year for property management (which is what our property manager charges per property). So, with $30,000 in income, we will actually be showing a loss on paper of -$4,672 (once you deduct depreciation ($11,272) and mortgage ($22,200) and property management ($1,200)).
However, in reality the property would be cash flow positive by $6,600 per year. This also doesn’t account for the principal pay down you are also getting on the back end, which is not being taxed either and is growing each and every year a tenant is paying down your mortgage for you.
You could then defer taxes indefinitely through 1031 exchanges. Or if you did sale, the gains would be taxed at capital gains rates, assuming you held it long enough 😉
But we still have work to do on putting the plan together and more importantly on executing the plan.
As you know, rental properties for me.
I don’t have a target for passive income because I know my peak spending years are in front of me still. We are going to have kids someday and those little boogers are expensive! So I view passive income and investments as starting the snowball that keeps gathering mass. The more I can do now, the better I will be in the long run.
I started checking out Jason Hartman’s site again.
I still can’t believe how cheap some of those properties are. Some of them are cheap enough that we could almost pay cash for them.
Thanks for continually reminding of this…we probably need the next 6 months to continue building up the cash stash, but then again that may just be another form of procrastination.
The key to passive income needs to be sustainability. Is a 15 pct return doable, over many years, including a real estate crash like 2008?
My sources will be the 4 pct rule, option trading for bonus income and maybe rental
AmberTree – I think we are talking two different things. It sounds like you are talking about the safe withdrawal rate, where I am trying to figure out how to generate enough cash flow, that I will never have to touch the principal.
Eyes on the prize! You and Mrs. GYFG are high-speed, and highly motivated! A coupla, three thoughts…
•Am liking that you obtain your ‘cushion’ by subtraction; you are already killing it on the income-side, so elimination of your mortgages is a remarkable expense to get out from under. This is also a form of ‘risk-management’, which both you and I are big fans of!;-)
•Assuming that the $120K includes income taxes (and FICA, SDI, FUTA, Medicare, blah, blah, blah), and once you and Mrs. GYFG decide to step off the hamster wheel you may find many tens of thousands freed up in additional cushion.
•Mrs. Ceezy and I have found that once we hit FI/RE, and we had been to 30+ countries and traveled on vacations, we no longer had the urge to roam. Controlling our time has also freed us from many desires (like travel), which were based (it turns out) on our feelings of being chained to our jobs. If you can make your home your favorite place to be, that can be freedom of another sort.
Cheering you on, GYFG!
JayCeezy –
– Risk Management comes first in all that we do. It’s easy to get caught up on the return side of the equation, but I am always looking at risk mitigation and margin of safety first.
– Once you eliminate the mortgages and we have the home improvement projects behind us (which we are getting close), then $120,000 should be inclusive of taxes, but like you mention the savings on taxes wont be realized until we step off the hamster will. However, depending on the sources of income, it should help lower our effective tax rate, for things that are taxed at capital gains rates and not ordinary income.
– I guess we won’t know on the travel front until we get there. But thanks for the perspective to keep in mind.
Cheers!
What are your thoughts on Commercial Real Estate? With $1 million, you could achieve some nice returns out of state – just a thought.
For me, I’m at 16k in passive income from my rental property, but that goes towards servicing the mortgage on the property.
Erik, what are your Property Taxes? Repair expenses? Annual mortgage payments? Annual depreciation? What is your sink amount into the rental property, so the lost opportunity cost and risk-free returns can be subtracted?
The $16K is not enough information to be meaningful.
Erik – The only exposure that we currently have to commercial real estate is through a REIT called Rich Uncles. We are currently auto-investing $500/month there.
What is the annual cost to service your mortgage (including property taxes, HOA, and insurance)?
Thanks for detailing out the plan. This is exciting to see you implementing this. Passive income is indeed the golden goose of investing. Looking forward to your future updates.
Thanks Mao!
Good post. I’m on a similar quest for passive income. Currently with combination of SFH rental income, dividends, interest, and Peerstreet hard money lending. I’m a year into other commercial real estate crowdfunding through Crowdstreet and RealCrowd through the equity portion of the capital stack. Used to do Realtyshares but sponsor quality is a step down. A lot of the deals pay around 8% pref during the 3-5 year hold. At exit, you can make 15-20+ IRR. Obviously risk is involved. I’ve trying to mitigate that risk by going with high quality sponsors, diversifying across funds and single deals across different asset classes and geography. As I get more educated, I will likely allocate more funds into commercial. Through my investment group, I’ve discovered many great sponsors so doing some direct investments off-platform. Barrier to entry for a lot of people is accredited investor qualification and high minimums. I recently experimented with Yieldstreet doing law cash advance. 13% yield. S o far doing ok.
Hey RadCrowd – It sounds like you have a good thing going.
YieldStreet looks interesting. I hand’t checked it out until you mentioned it. That maybe something else to put on the table as potential opportunities.
Let me know if you are ever interested in writing a guest post about your experience on the different Real Estate platforms online.
Cheers,
Dom
I think we’ll primarily be in stocks and bonds, but I would like to diversify into real estate further. I do own a lot of REITs now, will investigate Peer Street further, and have considered Realty Mogul also.
I have avoided owning rental real estate outright in the past, fearing the potential hassle of being a landlord, but when housing eventually blows up, if I can buy something at a fraction of its value that will cash flow well it will probably make sense from a diversification perspective.
If you go into physical real estate, I would highly recommend a property manager. That is the only reason we are still real estate investors. We found out early on that we are terrible property managers. It is the best $100/month that we spend (we currently only have one rental property).
GYFG,
I don’t perceive rental property management to be all that difficult. So I was wondering why your perspective is that you are not very good property managers. Is that due to focus or just skill? It seems to me you have been pretty successful in corporate america which definitely takes time and effort. I would think you would be great at property management if that was your goal.
Midwestern Landlord – I think we are not good property managers due to the following:
(1) Bandwidth – or lack of bandwidth. We all only have so much time in the day. My wife and I already work very demanding jobs, so the last thing we need is to worry about collecting rent, or fixing issues on the property.
(2) Push Overs – we don’t do well with rent collection issues. We are too understanding and it because a huge stress. We also don’t want to have to deal with evictions and what not.
(3) Value of our time – Our time is worth something. At $100/month, even if the property manager only spends an average of 1 hour on our property, that is is still less than an hour of my time. Based on where I am compensation wise, I value my time at $150/hour. This wasn’t always the case.
Cheers,
Dom
Just to chime in here. It depends on what stage of life you are in. If you are just starting out and have little money but lots of time, then yes, self managing makes sense. If you are busy making a high income w/ young kids at home, then self managing is NOT the highest and best use of your time. The key is to find a great property manager and manage THEM.
I have a rental house 1 hour away and I hire a property manager. They are fast and efficient because they have systems and economy of scale. These are just some of the things they do that I don’t have the time, knowledge or patience for:
They have the tenant sign a bunch more paperwork than the just the rental agreement – this is to protect me and the property manager.
Their in-house handyman can make repairs faster and cheaper than if I had to take time off work, drive there, find someone to fix something.
My manager can have a home moved out, cleaned, turned around and rented in 1 week. That decreases vacancy and saves me a lot of money.
Pre move-in check is extensive. They take hundreds of pictures of the house down to each baseboard, electrical socket and light switch. Then they do a safety check every 6 months and a drive by w/ photos each month.
They market and show the house, screen tenants, run background checks, check references, collect rent, take all tenant calls,etc. I get a nice convenient monthly and annual financial statement that I just hand over to my CPA.
In short, I don’t want to do any of that stuff and I happily outsource it so I have time to make more money and be with family.
Well said!
wow your blog is getting really popular! I had to scroll down for a while to get to this comment section. Hope all has been well with you. I love this post because if anything, passive income is the only thing I really track. Nothing will be more satisfying than the moment my passive income covers my life style. That being said, I do recall you saying you were after $50k per month in passive income (roughly $10M) at some point, is that still your goal? Is this blog post just about covering the basics, but not your actual goal?
Just a quick update on my end. We finally broke $600k, and are at roughly $610k today. Work has been steadily progressing and I have landed several high-end executives at fortune 500 companies recently. This could really open my door and allow me to focus on high-end clientele exclusively, so fingers crossed that I can keep these developments moving forward.
Great post!
Sean
Hey Sean,
You have a very keen memory indeed. You are correct, the $120K is just milestone number one in order to cover our lifestyle, but the longer term plan is still to generate $50,000/month and accumulate $10M in net worth. Have to crawl before we can walk, and then eventually run.
On the net worth front, congrats on hitting over $600K. We will cross the $600K barrier in August.
Nice work on catering to the high-end executives, that will go a long way in building your AUM book, and the more you get….the more you are likely to get.
Cheers
Hey GenY, love this post, sorry it’s taken me so long to chime in. I’d love to build passive income, but I don’t have a specific target. I’m in the stage where I view every investment on its own merits — some are for yield, some for appreciation, etc.
I just wrote a post about my investment LLC where I own shares of farmland, commercial RE, and a small business. Would love to hear your thoughts: http://www.pennyandrich.com/rich-llc-story/
Hope you’re having a fun summer –Rich