Passive income. It’s the El Dorado of the financial independence world. Everyone wants it, and everyone thinks they know the best way to find it. Some people swear by rental properties, others invest crowd funded real estate projects. A few even manage to find it by investing in stocks and bonds.
Passive income (as you might expect) isn’t easy to find, especially in the low interest rate world in which we live in today. With 10-year treasury yields under 2%, making a good income passively is a challenge. Some people take big risks to jump-start their path to financial independence — Fast income growth and higher passive income yields usually mean taking much larger investing risks (typically).
Adding risk his NOT a move I’m interested in making to grow our passive income. Today I’m going to discuss our plan to grow passive income in 2020, and how we’re going to do that WITHOUT taking on bigger risks in 2020.
Our Passive Income, A Review
Last year (2019) was a very good year for the Tako family passive income. We earned a total of $58,576 in 2019 — primarily from stock dividends and interest income. The year before (2018) we earned $51,230. That’s a growth rate of 14.4% year over year!
We did this via two methods:
- By investing spare cash into income producing assets (external compounding).
- By allowing our existing investments to retain capital and reinvest it (internal compounding).
Both methods are important components of income growth, but only one of those methods really moved the needle in 2019.
In 2019, my income growth plan included investing $108k of new capital. That was the plan at least. What actually happened was I only invested $17k of new capital in 2019. Really! The rest of our income growth came from internal compounding.
In other words, I failed miserably at adding capital to our portfolio like I planned in 2019. Dividend increases from our existing investments actually managed to help us achieve our goal of passive income growth in 2019.
In other words — Existing investments had large distribution growth last year
A Word About High Yield Investing
Unfortunately most people take one look that big dividend income number and then lump me into the high yield investor category. This is entirely untrue.
I try very hard to avoid the stink of high yield. Our taxable portfolio only yields about 2.4% using 2019’s income numbers. While this is higher than the average yield of the S&P 500, I would hardly classify it as a high-yielding portfolio.
High-yielding investments tend to be fairly high risk, and while they do provide a large amount of income this is usually at the cost of lower total return. Sometimes high-yield investments are value traps that need to be avoided as well.
IMHO, the risk of permanent capital loss tends to be higher for high-yield investors. Which is why I don’t consider high-yield investing a recipe for success. If anything, I believe we should be de-risking our portfolio even further in 2020….
Plans For Growth?
When it comes to growing passive income in 2020, I’m far less optimistic than I was in 2019. The bull market has been roaring for over 10 years now… and that’s a very long time. How long can this continue without a blip?
To quote CNBC, “Tepid productivity suggests the economy is unlikely to achieve the Trump administration’s goal of 3% annual growth.”
Personally I believe these to be very good warning signs for the year to come.
It feels like the exact same thing is going to happen in 2020 that happened in 2019…. I’ll take one look at stocks on my watch list and say, “Gosh that’s really expensive!!” And then I won’t buy any.
My plan is to NOT commit new capital in 2020. When free cash flow yields for the S&P 500 are less than 4%, it seems to me extremely prudent to keep cash on the sidelines… which is exactly why I maintain a big fat cash-pile.
This is not to say that stocks can’t or won’t go higher in 2020 — they totally can! According to Goldman Sachs, last year’s stock returns were primarily fueled by PE expansion, not earnings growth.
This could happen again!
Remember: Stock price increases and PE expansion do not create passive income. Only compounding and earnings growth from economic expansion will create passive income. Just because stocks go up, does not mean passive income goes up!!
At this time, it does not appear that earnings growth will be significant in 2020. This is why my passive income growth plans for 2020 are extremely limited — I’m targeting dividend growth of only 4% in 2020, with no new capital invested… unless some absolutely fabulous investment materializes (unrealistic at this time).
This means a projected dividend income of $61,000 for the Tako family in 2020. My plan is to basically keep up with inflation with only a tiny bit of earnings growth.
While this might not seem like a very aggressive plan after seeing my incredible portfolio grow last year, it does seem prudent and realistic to me. This year, I’m not looking to add a bunch of risk for a couple extra percentage points of investment income.
Given the expensive state of the stock market, and the likelihood of poor economic growth, I’m going to be de-risking in 2020 and targeting only a very small amount of income growth. 4% seems a fair goal given the fact I don’t intend to commit new capital.
A passive income of $61,000 should be sufficient to meet most of our expenses in 2020, provided I don’t buy another new car. Given the state of the economy, I’ll probably put off other large purchases in 2020.
Am I being too conservative and too cautious? What do you think? Let me know in the comments!
[Image Credit: Flickr]