A lot of investors, especially retirees, crave passive income. According to legendary value investor and Berkshire Hathaway chairman Warren Buffett, “If you don’t find a way to make money while you sleep, you will work until you die.” What are the best passive income investments that you can add to your portfolio?
First, like with any other investment, investors should take into account their risk-return appetite and investment goals when selecting a passive investment. If you're a young investor with recurring income, passive income investments might not interest you. Also, passive income investments are spread across different asset classes, and all of them have different risk-return payoffs.
What are passive income investments?
As the name suggests, passive income investments generate regular returns without the investor doing anything. This is unlike active investments like a trading portfolio where the investor needs to take active portfolio actions to generate returns.
How many passive income investment options are there?
There are multiple passive income investment options, which are both active and passive. In the equity space, dividend stocks and dividend ETFs are passive income options. While dividend stocks are an active investment, an ETF of dividend stocks is a passive investment.
Within dividend stocks, midstream energy companies, banks, and utility companies pay good yields. REITs are another good passive income investment option and you can choose from commercial REITs as well as mortgage REITs.
However, it's worth remembering that dividends aren't a fixed contractual payment and when the tide turns for the worse even the best of companies can slash dividends.
For example, in 2020, several well-established companies like Ford and Disney suspended their dividends. Also, several companies slashed their dividends. Since then, many companies have restored their dividends, while some companies like Disney haven't yet.
Investing in real estate through pooled investments is an option.
You can take direct exposure to real estate also. Generally, commercial real estate has a higher rental yield compared to residential real estate. However, investing in real estate directly would be an active investment in itself and you would need to manage the property, including regular maintenance.
Since investing in real estate is cumbersome and the initial investment is high, some investors shy away from investing in real estate. Instead, they choose pooled investment options like REITs. Also, there could be periods where the property is vacant and wouldn't yield any income.
Fixed income passive income investments
If you're a risk-averse investor, you can build a passive income portfolio through bonds and other fixed-income investments. Unlike REITs and dividend stocks, the income from fixed-income investments is mainly predictable and stable. The yields could be quite low though compared to the other passive income avenues.
P2P (peer-to-peer) lending is another attractive passive income investment option. It has emerged as a popular asset class over the last decade thanks to low-interest rates on other fixed-income options. P2P lending is risky and the default rates are high.
Some investors also look at cryptos for passive income. However, cryptos are a high-risk investment and their prices tend to be volatile.
Passive investing is an attractive investment option, especially for retirees who need regular income from their investments. The key to prudent financial planning would be to diversify your portfolio across multiple passive income assets to hedge the portfolio.