How to Optimize a Portfolio for Passive Income
Passive income gets a lot of attention these days, and it exists as a dream for many—both as a way to increase your total revenue and build wealth faster and as a way to fund your retirement. The idea behind it is simple. Create income sources that don’t require much (if any) ongoing upkeep and keep them running indefinitely. Over time, you’ll accumulate money passively without continuous effort. You can also use that money to fund further passive income strategies or pay for your basic living expenses.
So what’s the best way to optimize your investment portfolio for passive income?
Why Passive Income?
First, let’s establish why you might want to optimize your portfolio for passive income in the first place. There are several possible motivations, including:
Diversifying revenue streams
Most people understand the importance of diversifying a portfolio to balance risk, but diversifying revenue streams is also important. With more revenue streams, losing a single revenue stream can’t make that big of an impact.
For example, let’s say you have a full-time job, a part-time gig, and a passive revenue stream. If you lose your full-time job, you’ll have enough income to scrape by, giving you the buffer you need to find a new job.
If you start early, passive income can help you build wealth as well. Rolling your income into additional investments allows you to snowball your earnings.
For example, let’s say you earn revenue amounting to roughly 4 percent of your principal each year; if you reinvest this, you’ll double your investment in 17 years or so.
Establishing retirement income
Most people dream of a retirement where they don’t have to work yet can generate a significant income. Passive income, the insufficient volume allows you to do this. The income generated passively tends to be consistent, so you can count on it when you need it.
Minimizing effort and freedom of time
You might also be interested in passive income as a way to minimize your effort or the number of hours you work every week. For example, you might be looking for a career that allows you to spend more time with your family.
Examples of Passive Income Sources
So, how can you balance your portfolio for passive income? You can shift your investments to the following sources:
An income-generating business
Several business models rely on passive income generation. For example, you might start a business that sells products on marketplace websites, allowing you to capitalize on a small profit with every sale, but requiring minimal ongoing upkeep.
Starting a business like this takes a few months of work (in most cases), but you could also consider buying a business that already exists and using it as a way to generate revenue.
If you’ve spent any time investing in stocks, you know the power of quarterly dividends. Many major companies distribute profits to shareholders regularly in dividends, typically paid quarterly, and often amount to a total payment of 2 to 4 percent per year.
In other words, for every $100,000 of stock you hold, you could be generating $2,000-$4,000. You can also enjoy the benefits of capital gains if the stock prices increase while you’re holding them.
If you’re interested in hedging your bets, you can buy multiple dividend-paying stocks simultaneously with the help of an ETF or a mutual fund.
If you want to shield yourself from the stock market volatility, you can also generate passive income with the help of real estate.
Whether you purchase commercial or residential real estate, as long as you can keep your building occupied with tenants, you should be able to generate recurring income through rent, exceeding your typical expenses.
You may also be able to capitalize on appreciating property values, especially if your property is in an up-and-coming neighborhood, giving you an alternative way to build your wealth over time.
Bonds and peer lending
Purchasing bonds is a formalized way of lending your money to governments and corporations; these institutions will pay you a fixed percentage of interest each year for a fixed period and will pay back your principal at a specified date.
You can also take advantage of peer lending platforms to loan your money to other people, generating interest payments in an amount that varies based on the borrower’s risk profile.
A blog typically requires a bit of ongoing effort, including creating regular new posts and regular maintenance for the site. However, for the most part, a blog with sufficient traffic will be capable of producing a stream of revenue all on its own.
You can monetize the blog with advertising, affiliate links, merchandise, and other options.
Images, video, and other content
If you’re in the content creation business, you may be able to make money with photos, images, videos, and other forms of premium content. For example, you could take stock photography and make money selling those images on a stock photography platform.
You could also write an eBook and list it for sale. Even if you’re only making a few dollars per transaction, this money can add up if you’re getting hundreds or thousands of transactions.
A mobile app
You can also make money by developing and distributing a mobile app. You could monetize the app by charging money for the initial download, hosting advertising, or facilitating microtransactions for purchases within the app.
Assuming you can generate enough interest in the app, this is a viable income generation strategy—but it’s not truly passive, since you’ll need to make regular updates to keep the app running.
No matter what combination of passive income generating strategies you use, make sure you keep your portfolio diversified with a mix of different sources.
The Weaknesses of Passive Income
Though passive income is very powerful, it does have a few weaknesses worth considering:
No matter what, your passive income strategy will require something from you in the beginning. Sometimes, that means an upfront investment. If you want to make $40,000 a year from dividend-paying stocks, for example, you’ll need at least $1,000,000 in upfront capital. This isn’t always feasible.
If you don’t need to pay money upfront, you’ll need to invest effort upfront. For example, it will take time to establish a blog, develop a mobile app, or build up stock photos and videos portfolio.
Generally speaking, many consistent, income-focused investments carry lower risks and lower overall returns than other investment types. If you’re looking for a high growth strategy, passive income may not be the best optimization route.
Dependencies and timing
Some passive income sources are dependent on many variables going your way. If you have bad timing, bad luck, or insufficient due diligence to back your play, it could actively work against you.
Tips for Balancing a Portfolio
If you’re balancing a portfolio to include more sources of passive income, there are a few important additional tips to follow:
Establish your high-level goals.
Before you begin building your investment portfolio (or rebalancing one you already have), you should understand your high-level goals. What are you hoping to achieve? Do you have an investment time horizon? What is your risk tolerance? The more answers you have, the easier it will be to balance your portfolio appropriately.
Do your due diligence.
Never assume that a passive income strategy will work just because it seems appealing or because it has rave reviews. Always do your due diligence, and understand what you’re getting into before you sink any time or money into a strategy.
Diversification is the best tool for protecting your assets, and it’s vital if you want to succeed. That means diversifying your revenue streams, diversifying your investments, and even diversifying your holdings within each strategy. For example, you might include dividend-paying stocks as part of your investment portfolio. But, within that category, you should include many types of businesses in numerous industries.
Analyze and re-balance regularly.
Balancing a portfolio isn’t something that happens only once; it’s something you should be doing periodically, every year, or every quarter, depending on your goals. Analyze your past successes, reevaluate your goals, look at your time horizon, and apply new changes as necessary.
Is Passive Income Always a Good Idea?
While passive income sounds like a picture-perfect investment strategy, you should note that you cannot ignore the drawbacks. Remember, passive income sources often require a significant initial investment of time and/or money to pay off. They don’t always yield as high a return as some other, more aggressive strategies.
If you’re interested in building as much wealth as possible over the long-term or trying to make your investment strategy as simple as possible, passive income shouldn’t necessarily be the highest priority or the exclusive focus of your portfolio.
That said, almost any investor can benefit from the power of passive income. What matters is that you keep your portfolio diversified and balanced in a way that caters to your specific goals as an individual.