The Top 7 Best Passive Income Investments
Having the comfort of knowing your portfolio is generating value is great. Being able to have your money work for you by generating passive income is even better. Passive income investments provide a fantastic opportunity to take a one-time investment and turn it into a recurring source of income without having to do much (if any) work to realize gains.
Passive income investments include being a silent partner in a business, owning rental property, and dividend-yielding investing. These are the most common types of passive income investments, but are by no means the only options available. There are also plenty of options by way of the stock market and alternative investing as well.
Not all passive income investments are created equally. Some offer a larger revenue stream than others, but require more capital to get started. Others may seem like a safe bet, only to decline in value depending on the whims of the market. The best passive income investments should provide you with a balance between risk and reward; moreover, they should also require very little work on your part to turn a profit.
Here are the top five passive income investments, in no particular order and all with their unique benefits, that provide returns—be they big, small, inexpensive, or capital-intensive.
1. Real Estate
Real estate is perhaps the most well-known option as far as passive income investments are concerned. You can opt to buy real estate yourself, be it commercial or personal, and rent it to businesses or individuals. Alternatively, you can invest in a real estate investment trust (REIT). You can also invest in farmland, but we’ll get into that in more detail later on.
One of the biggest draws for real estate as a passive income investment is its ability to retain value in most economic scenarios. Real estate value isn’t dependent on stock market fluctuations, and can withstand broader economic downturns. Property values even managed a modest rise on average in September 2020 despite the COVID-19 pandemic. This was the highest one-month increase since the real estate boom of the mid-2000s.
You can also pick out real estate just about anywhere in order to get started. That might mean buying a rental property down the street or in a booming city somewhere across the country. Your options are limited only by your budget and imagination, which means this asset class can fit within whatever role for your portfolio that you want.
Real estate investing also comes with a significant amount of flexibility as far as startup capital is concerned. You can start small, perhaps with a small one-family home, or go for the gusto and buy a building with several units. This allows you to fine-tune the amount of money you want to put into the property—better still, it makes it easier for you to dial in the right amount of risk for your investing goals.
The more straightforward way to make passive income quickly is through rental property or participation in a REIT. Rental income delivers steady monthly checks from which you can take some of all of the proceeds. You’ll likely have to put some of this income back into the building, but you’ll still walk away with the lion’s share of the profit. A REIT, on the other hand, is hands-off in terms of having to maintain the properties in your portfolio, but you’ll get less of a payout. You’ll get a proportional amount of money based on your investment amount after management fees are deducted.
Buying Rental Property
Purchasing a rental property is perhaps the most straightforward way for making passive income through real estate. You can make passive income through real estate by way of rental income as well as equity. Rental income offers faster returns whereas equity is a long-term play that’s tied to increasing property value.
There are several factors you need to consider as a burgeoning landlord. For starters, your rental property won’t always be occupied: tenants come and go, but mortgage payments and utilities stay even after the last moving box is on the truck. Consider how many months out of the year you can afford to keep up with mortgage payments without a tenant in place. You’ll want to make sure you have enough liquidity to make payments, even when you’re in between renters.
Bear in mind that you may need to sink some of this income into making renovations or repairs, depending on the condition of the property. You’ll also have to pay for insurance, property management fees, waste management, and recurring upkeep. These are all unavoidable expenses that will bite into your recurring rental income when you invest directly in real estate. That will delay how quickly you begin to make passive income through this investment. You’re not guaranteed to see your property appreciate in value, either—or at least not as fast as you might hope.
Investing in a REIT
Whether you buy real estate on your own or with business partners, you may find that you’re doing a significant amount of work to make “passive” income on your investment. If that prospect doesn’t sound too alluring, you might want to invest in a REIT instead. You won’t have to worry about finding real estate opportunities and managing a property when you invest in a REIT, which means you can sit back and enjoy passive income with far less work.
REIT investing is like fractional property ownership. The amount you own depends on the size of your investment. A larger investment gets you a larger return, which means more passive income for you. Plus, with a REIT, your investing dollars can go further: the management firm takes care of maintenance and repairs and deducts a certain percentage from your return. That means you won’t have to dive into the nitty-gritty of maintaining a property like you would if you invested in real estate individually.
All of the typical expenses that come with renting a property, such as Plus, REITs tend to benefit from low-interest periods, which means they can be an alluring investment when inflation is high and bond rates are no longer a worthwhile diversification option.
2. Farmland Investing
Buying property and REIT investing aren’t the only options you have as far as passive income through real estate is concerned. Farmland investing is one of the best passive income investments in real estate, given its versatility and steady historical performance.
Farmland investing has enjoyed resilience and steady growth, even during recessions and market turbulence. Throughout the past ten years, American farmland has risen in value over 6 percent each year. The annualized return rate for US farmland exceeds that of forestry, gold, commodities, and the S&P 500. With the exception of forestry and Treasury bills, farmland investing beats them all in terms of stability as well. The same can’t necessarily be said about other real estate investments, which varies significantly depending on location and the individual value of the property owned.
One of the other unique value propositions farmland provides is its triple revenue sources. First, the land itself can appreciate, making your investment more valuable. Second, the crop yield from the farm can also bring in passive income, with a portion going to investors after harvest. Third, you earn returns from standard farm operations and lease payments. Having multiple revenue sources can help ensure that you have money coming in from your investment without having to depend on one performance element. This is a key differentiator for farmland that other real estate investment types can’t match.
When you invest with FarmTogether, you’re given a choice of opportunities that are earmarked to deliver anywhere from 3 to 9 percent cash yields—an enviable sum compared to other passive income investments. This makes farmland investing a much more compelling prospect than bonds, which historically offer steady returns with low volatility. Farmland offers significantly higher rates of return than bonds, however. This is especially true when interest rates are at rock-bottom.
3. Dividend Stocks
Dividend-yielding stocks are a great addition to any portfolio, and investors can find several of them in nearly any sector. Companies that offer dividends to shareholders either provide them as cash payouts or by way of additional stock. If you’re focused on making passive income, these assets can deliver cash on a recurring quarterly basis (as long as the stock performs well, of course). This translates into a recurring source of passive income, or the opportunity to turn your gains directly into more stock.
Some sectors are known for having more dividend-yielding stocks than others. REITs lead the way: their tax structure requires them to pay out 90 percent of their profits to investors by way of non-qualified dividends, meaning that they need to pay out investors on a recurring basis. The tech sector is less dividend-driven, primarily because these companies are newer and reinvest profits into their business instead.
Most other sectors and individual stocks land somewhere in the middle: and large-cap companies are usually more inclined to pay dividends. These businesses don’t tend to have the same need to reinvest as upstart rivals or smaller companies looking to grow. Many dividend stocks are therefore associated with industry incumbents or long-standing businesses. They may not make you rich through skyrocketing stock prices, but they will offer you a steady source of passive income.
Companies don’t typically advertise that they pay out dividends to shareholders. However, you can look into an informal category of stocks known as “Dividend Aristocrats.” Dividend Aristocrats are S&P 500 listed companies that have paid out increasing dividends to shareholders every year for at least two and a half decades. This is a pretty high bar to set, meaning that any of these companies are likely to continue offering dividends in the future.
There are a few potential downsides to investing in dividend stocks, depending on your strategy. These stocks tend to be low-growth: you’ll make a modest return and get paid dividends, but you shouldn’t expect double-digit growth. If you want to turn a fast return on your portfolio, these assets won’t help you get there. Plus, you have no guarantee that a dividend-paying stock will do so in the future.
4. Investment Funds
Be they mutual funds, index funds, or exchange-traded funds (ETFs), investment funds are a common go-to for people who want to avail their portfolio to passive income. This investment type takes the stress (and risk exposure) out of buying stocks yourself: instead, the fund invests in several stocks or other publicly traded products on behalf of the fund participants. You don’t have to pick out and monitor each of your market positions this way, as you’re leaving that work to a manager or algorithm.
Much like dividend stocks, investment funds don’t pay out cash to investors. Rather, they can incorporate stocks into their holdings that are likely to pay a dividend to shareholders. Since you’re a shareholder by way of the index fund, you get a piece of the pie, which generates additional value for your investment.
Mutual funds are the most well-known investment fund for your average investor. Mutual funds are either passively or actively managed by an investment manager who then takes a percentage of the fund’s returns. When you invest in a mutual fund, you’re able to take a more hands-off approach to running a vital part of your portfolio. The fund manager picks the assets and the size of the investment—all you need to do is track your investment’s returns and the fund’s overall performance.
There are downsides to investing in a mutual fund, however. Manager fees can be expensive, which cuts away at your potential passive income. Every manager also takes their own approach to building the fund’s holdings. You may not agree with a few investments in a fund, or the fund manager might be swayed by gut feelings about an asset instead of cold hard figures.
Index funds offer another solid option for passive income investing. These funds function similarly to mutual funds, but without the management fee. Instead of being actively managed by a financial institution, index funds make asset allocations based on proprietary algorithms. This maximizes upside for investors while reducing costs, such as manager fees and others.
Index funds may not have the blockbuster returns of real estate, farmland, or dividend-generating stock investments, but they do produce a reliable source of passive income as your holdings of the fund remain intact. Plus, they’re far less expensive than other passive income opportunities in terms of fees.
ETFs can be another compelling option for investors who want maximum flexibility. Unlike with mutual funds, investors can buy much smaller amounts of ETFs for their portfolio. That’s because these funds are traded as stock market shares. Mutual funds, on the other hand, require investors to hit or exceed an investment minimum.
Not all investment funds are created equal when it comes to minimizing fees and maximizing passive income opportunities. Mutual funds, for example, come with manager fees that can eat away at your returns. Index funds and ETFs are a less expensive option from a fee perspective, but may not give investors the kind of nuance needed to build the optimal passive income portfolio.
5. Intermediate-Term Fund
You may be familiar with mutual funds, index funds, and bonds—three steady investment options that, while unglamorous, offer stable returns. You may not have heard of intermediate-term funds, however.
An intermediate-term fund bundles together a slate of bonds that mature between 5–10 years. The fund collects money from several investors and uses it to select from a range of bonds. With an intermediate-term fund, you’ll diversify your portfolio without having to source the best bonds yourself: many of the top offerings include well-rated bonds that offer significant payouts, meaning you’ll prime yourself for growth without tons of research.
In this regard, intermediate-term funds are similar to mutual funds and REITs: you can leave the heavy lifting to the professionals and focus on long-term performance instead. This can provide a great opportunity for investors who want to make the most of their money without sacrificing quality for convenience.
Intermediate-term funds have a good track record of delivering results, too. One of the leading funds has a five-year annual return average of just over 4.3 percent. The underlying bonds tend to have a maturity rate of anywhere from eight to 15 years, meaning you’ll have to play the long game in order to realize your gains. If you’re willing to be patient, however, you could easily see your money growing on its own.
Beware of inflation, however: when the dollar loses value, you may find your long-term bond investment doesn’t equate to as much cash as you’d hoped for when you first added it to your portfolio.
6. Peer-to-Peer Lending
Peer-to-peer lending is a somewhat new phenomenon within the world of passive income investments. About 10 years after its inception, this investment category has demonstrated a track record of solid returns for investors, with returns ranging from 7 to 12 percent annually. Plus, peer-to-peer lending requires little to no work on the part of the investor after they’ve made their initial deposit.
Instead of lending or investing in a business on your own, peer-to-peer lending companies pair investors with a selection of opportunities that they then manage on investors’ behalf. The barrier to entry for this kind of investing is lower than that of a private equity fund (more on that below), making it appealing to qualified investors who may not want to put such a significant amount of money into one holding.
There are downsides to peer-to-peer lending, however. By participating, you’re inherently taking on more risk than you would through a REIT or farmland investing. The quality of the investments may vary, and you’re not necessarily primed for long-term returns the same way you would be with these and other opportunities. For example, farmland investing can give you a more stable underlying investment, which could be a better fit within your passive income investing strategy. If you’re willing to expand your horizons, however, you may stand to gain by venturing into this passive income opportunity.
7. Private Equity Investing
Private equity investing is an excellent option for making the most of your passive income investment. Private equity surpasses typical return rates of other managed investments, averaging just under a 10.5 percent annual return for the past two decades. This can be a worthwhile opportunity for high net worth individuals that can afford to put at least $250,000 on average into a fund.
When you invest in private equity, you expose your portfolio to a range of investment opportunities outside the stock market. This includes investing in private companies, participating in leveraged buyouts, and other opportunities that come with a higher potential return than most conventional investments.
Investing in a private equity firm is inherently risky: you don’t have the same oversight and regulation with this option as you would with an index fund or direct stock ownership. But, on the other hand, you’re unlikely to generate anywhere near as much passive income with either of those options as you would through private equity.
If you do decide to go with private equity investing, be ready to pay hefty fees. Most firms charge a 2 percent management fee based on assets, as well as an average 20 percent of profits made.
The Best Passive Income Investments
Ultimately, the best passive income investments are those that align with your overall portfolio. If having a small amount of recurring income with minimal work is the goal, then a hands-off approach through a managed investment is the way to go. If, on the other hand, you’re willing to get your hands dirty and take an active role in your passive income investment, delving into some of the other, higher-yielding options may be right for you.
For those who want the best of both worlds—a high opportunity for passive income with minimal work—farmland investing is the clear favorite. Getting started with FarmTogether is simple, and the upside is enormous.
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Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.