This article covers my five favorite passive income investments. As I discuss these investments, I provide practical advice to help all the beginning investors out there plan to make your money work for you. The process of investing has become so much easier and cheaper in recent years through technology advances and consumer-friendly business improvements. Investing should be accessible to all adults with basic computer or mobile phone skills and the ability to do a little a research and reading online.
Defining Passive Income
Let’s get straight to it by defining passive income, which has become a buzzword on the Internet and practically overused to encompass all sorts of schemes it probably shouldn’t be associated with. When I talk about passive income investing, I am referring to doing a little work upfront to set the wheels in motion and then the money steadily rolls in for you after that.
An article on Dave Ramsey’s website written by Chris Hogan defined passive income as, “Money you earn in a way that requires little to no daily effort to maintain. Some passive income ideas—like renting out property or building a blog—may take some work to get up and running, but they could eventually earn you money while you sleep.”
How do we apply this to investing? The author of “The Intelligent Investor,” who is also known as the father of value investing, Benjamin Graham advised, “The real money in investment will have to be made … not out of buying and selling, but of owning and holding securities, receiving interest and dividends and benefitting from their long-term increase in value.” That certainly sounds like a passive income approach to me.
1. Dividend ETFs
The number one think I like to invest in for passive income are dividend ETFs. A dividend ETF is an exchange-traded fund that invests in a selection of companies that pay high-yielding dividends. These ETFs are typically composed of larger companies that have a long track record of paying dividends, and so tend to be a lower risk investment. A couple of the dividend ETFs that I like are the Vanguard High Dividend Yield ETF (VYM) and the SPDR Portfolio S&P 500 High Dividend ETF (SPYD).
Vanguard High Dividend Yield ETF (VYM)
Vanguard’s VYM tracks the performance of the FTSE High Dividend Yield Index and invests in growth and value stocks across diversified sectors and market capitalizations. VYM is currently trading in the mid 70s, which is in the middle of its 52 week range. At the time of writing, VYM has a dividend yield of 3.66% and a dividend rate of $2.74 per share (that means in a calendar year, given the payout remains the same, you would earn $2.74 for each share that you hold). The expense ratio of the ETF is very low at .06%. There are 402 companies held by the fund, with greater than 10% of assets in each of these sectors: financials, healthcare, consumer defense, and technology. The top five companies currently held are JP Morgan Chase, Johnson & Johnson, Procter & Gamble, AT&T, and Intel. By the way, I like using the website Seeking Alpha as one of my research sources and all numbers I’m quoting throughout this article were found using that website..
SPDR Portfolio S&P 500 High Dividend ETF (SPYD)
SPYD is a fund from State Street Global Advisors that tracks the S&P 500 High Dividend Index and the S&P 500 Index. It is invested in stocks of dividend paying companies and growth and value type large cap companies. SPYD has been trading in the $25 to $28 range for the past month, which is on the lower part of its 52 week range. The dividend yield is at 7.08%% and the dividend rate is $1.80 per share. It has a low expense ratio of .07%. Being invested in both SPYD and VYM allows for added diversification in my portfolio. SPYD has different companies in its top holdings, including Gilead Sciences, Digital Realty Trust, General Mills, Crown Castle International, and Kraft Heinz. Its top two investment sectors are real estate and consumer cyclical.
Dividend Reinvestment Programs
You have two options for the dividends you receive from your investments. You can have that money deposited into your brokerage account as cash or you can have the dividends invested back into the specific investment. To make this second option happen, you need to enroll in the dividend reinvestment program with your brokerage, known as a DRIP. You can toggle the DRIP on or off for each individual investment that is eligible for the program. When dividends are paid, the system will then buy shares at the current price with the cash you would have received. This is an easy way to grow your investments.
I tend to have most of my investments enrolled in a DRIP. I will sometimes turn off the DRIP for an investment if I am planning on selling all of it soon, since obviously I don’t want more of it! I also sometimes have turned off the DRIP if I believe the share price to be overvalued. When some of my investments were trading at 52 week highs in January of this year, I turned off the DRIP and took the dividend cash instead. I then turned the DRIP back on for those companies in early March as prices were coming down. That may be a bit more involved than most people want to be and I recommend that if you want to be truly passive with your investments, to turn the DRIP on and forget about it.
2. Large Cap Dividend-Paying Companies
My second favorite passive income investment is to buy stock in large cap companies who pay dividends. One could argue that I am covered enough in this category with my dividend ETFs and you would be right. But I invest in such companies because I have dug a little deeper into the available information about each company. I respect how the company is running its business and I see potential for growth in their future. I feel like I want to throw my support behind the company. Plus, by investing in individual companies, I am saving a small sum of money on costs, as there is no expense ratio to be covered.
When researching individual companies there are a few things that you should be aware of. Be careful of chasing a high dividend yield. A dividend yield percentage in the teens is a warning sign. I usually like to aim for a yield higher than 2% and less than 9%.
Also check the payout ratio for a company. As a dividend investor, you are looking for a number in the middle of the range to 100. A payout ratio greater than 35% and less than 75% suggests that you will be getting a good share of the profits back from the company. When the ratio is greater than 75%, proceed with caution as you want to consider whether or not the company will be able to sustain paying the dividend and continue to have enough money to invest back into the company. Anything over 100% is a red flag as the company is now paying more in dividends than they earn.
Note that these are loose guidelines and typical payout ratios can vary in different industries. When evaluating a company, you’ll also want to check out other financial stats such as the price to earnings ratio, earnings per share, debt to equity ratio, and market capitalization, to name a few. I only wanted to touch on the dividend related information here. In any case, be sure you have done your own thorough research so that you feel confident in your investment choices.
Dividend Aristocrats
If you are interested in finding reliable dividend companies to invest in, a good place to start is with the dividend aristocrats. A dividend aristocrat is a company that is part of the S&P 500 that has increased its dividends for 25 or more years. The list is updated annually and a company can drop off the list if it fails to increase its dividend or if it moves out of the S&P 500. You can easily find the list of about 60 companies on Wikipedia.
The dividend aristocrat that makes up one of the largest positions in my personal portfolio is the telecommunications giant, AT&T (T). Their current debt load is worrying, but I see a lot of potential for this company with the roll out of 5G and their new HBO Max streaming platform. Shares are currently selling for a very accessible entry price of around $28 per share. The dividend yield is just above 7.3%, with the dividend rate at $2.08 per share.
Planning in Advance When You Might Sell
Don’t forget that another way to make money is through the long-term increase in value of the stock you own. Make a plan in advance for what criteria you will use for selling your stock and harvesting your gains. How many years will you hold a stock? Will you set a target price at which you will sell? Or maybe you will set a percentage gain at which you will sell or begin to think about selling? You can also choose to never sell and pass your investments on to your beneficiaries. Remember that share prices can fluctuate, but dividends are not tied directly to the share price and you should receive them whether or not the stock is valued above or below your original buy price. However, a company may choose to cut or suspend their dividends, particularly if the share price falls drastically. You will want to check periodically that each of your investments is maintaining its dividends. Most financial experts recommend reviewing your portfolio at least annually.
Index Funds
On a side note, if you do not feel comfortable with picking stocks in individual companies, it is completely fine to invest in an index fund. In fact, this is a time honored investing strategy advised by financial gurus and writers, including Jack Bogle and Burton Malkiel. A couple excellent index funds to invest in are Vanguard 500 Index Fund Investor Shares (VFINX) or the Schwab S&P 500 Index Fund (SWPPX). Keep in mind that the average rate of return for an S&P 500 index fund is typically between 7% and 10%. Remember that this is the average if held over a number of years. During this past decade with the bull market run, according to US News, SWPPX returned 13.89%. You’ll still get dividends from these funds, with VFINX paying out a respectable 1.9% yield and SWPPX at a 2.19% yield.
3. Real Estate Investment Trusts (REITs)
If you read my previous post, you’ll already be familiar with my third choice for passive income investment: Real Estate Investment Trusts, known by the abbreviation REITs. That post introduces my experiment testing out how REITs I’m investing in through the stock market inside my E*Trade account, might perform against the eREITs in my Fundrise account.
Defining REITs
For those unfamiliar with this term, A REIT is a company that owns, finances, or operates income-producing real estate and may operate across various property sectors. People can own shares in individual REITs on the stock market, just like they can own shares in individual companies, and they can be traded easily, making them a liquid investment. Since REITS are required by law to pay out 90% of their taxable income as dividends, they are a steady source of passive income for investors. On the downside, REITs tend to have low growth rates of their share prices and their dividends are taxed as ordinary income.
One of my REIT Investments: W.P. Carey (WPC)
One of the REITs that I am invested in is W.P. Carey (WPC). WPC is a net-lease REIT that invests in high-quality single-tenant industrial, warehouse, office, retail, and self-storage properties in both the United States and Europe. I like the diversification across different sectors and locations found within this REIT. WPC is currently trading around $55 per share. The dividend yield is at 7.61% and the dividend rate is $4.16 per share. If you are looking at investing in REITs you may want to consider that, with the changes in the market over the last couple months, some REIT sectors are performing better than others, so be sure to carefully complete your research.
REIT ETFs: VNQ and USRT
If you like the idea of investing in REITs, but want slightly more diversity, investors can buy shares in REIT ETFs. My favorite of these in my portfolio are the Vanguard Real Estate ETF (VNQ) and the iShares Core U.S. REIT ETF (USRT). VNQ is currently trading near $70 with a yield of 4.62%, a dividend rate of $3.18 per share, and an expense ratio at .12%. USRT is trading in the high 30s. Its dividend yield is 4.80%, the dividend rate is $1.82, and the expense ratio is only .08%. These two funds were my first foray into the world of REITs, before I starting looking at individual REITs.
Opening a Brokerage Account
For beginners, to invest in dividend ETFs, large cap companies, and REITs, you will need to open a brokerage account. I recommend opening an account with a reputable company that charges minimal fees. I personally use E*Trade and TD Ameritrade, which both offer commission free trading, research tools, and have good customer service. I have also heard positive remarks about Fidelity, Vanguard, and Charles Schwab.
In the last couple years there has been a trend for mobile investment apps, such as Robinhood, M1 Finance, and WeBull. Remember, with so many of these platforms now offering commission free trading, it is okay to buy one share at a time so you can build wealth little by little with what you have. These apps are a nice way for a beginner to get started as the apps have simplified user interfaces for ease of navigation. These apps also offer sign up bonuses when you sign up using a referral link. If you would like to use any of my referral links for these apps, you can find them linked on my resources page. If you want to do additional research before choosing a trading platform, then do a Google search for “best online brokerage accounts” or “best investment apps.” If you are reading this from outside of the United States, just add your country name to the end of your search.
The stock market has shown a lot of volatility over the past several weeks — one day it’s up, the next day it’s down. Please think carefully about any investments you want to make right now. If you are thinking of investing in ETFs, individual stocks, or REITs, as I’ve talked about, only invest an amount of money into the market that you can afford to spare. Know that you might need to leave it there for a while to ride out any lows we may see. While I share a lot of my opinions in this article, this should not be considered as professional financial advice. Always complete your own research before investing in anything.
4. Fundrise
On to number four of my favorite passive income investments, which I mentioned briefly before — Fundrise. Fundrise is a crowdsourced real estate investing platform that allows people to diversify outside the stock market. It is also a way to invest in real estate without having to personally manage the buying and selling of properties, maintenance, home improvements, or tenants.
Money deposited in Fundrise should be thought of as a long-term investment as your money is locked into the platform. In fact, given the lack of liquidity in the underlying asset of real estate, Fundrise has temporarily suspended account redemptions (which means, if your money is in Fundrise, you are not getting it out right now). Fundrise has written a detailed explanation about this to account holders, saying, “Fulfilling redemption requests in today’s environment would mean either substantially depleting vital cash reserves, or even worse, potentially selling assets into a down market, and likely at a price far below actual value.” I’m fine with this as I always understood this to be a long-term investment and also because I have just $1,192 in my Fundrise account. I will likely add about $600 into this account this year. I’m taking a conservative approach while I watch how this company operates.
One of the reasons I like Fundrise is because despite the drop that happened in the stock market, my Fundrise account continued to grow. All the dividends I have earned through Fundrise have been automatically reinvested in their eREITs. I’ve had a return on investment in this account of 8.3% over the 15 months that I’ve been invested.
5. High Interest Rate Savings Accounts
We have reached my final choice for this list and it is the easiest option for generating passive income, though with the smallest return. High interest rate savings accounts are my favorite place to park my cash that I don’t want to have invested elsewhere. I use the Capital One 360 Performance Savings account, with an interest rate of 1.50% APY and the Discover Savings account, which lowered its interest rate this past week to from 1.40% APY to 1.25% APY. One of the accounts is dedicated to saving my cash for a future down payment on a house and the other holds my emergency fund. I like to keep my emergency fund in a different bank from the one that I regularly use. That helps me to leave the money there and only access it for a true emergency. Keeping your cash in a high interest rate savings account is not going to make a lot of money for you. Most of them will barely keep pace with inflation. But for goals or situations where you need to keep cash available, I feel that this is the best option.
Using Bankrate.com to Find a High Interest Rate Savings Account
For US-based viewers, if you want to open a high interest rate savings account, use the website Bankrate.com to search for the best current interest rates and the bank that you want to use. On the website home page click on the box for savings/mma accounts. Then you can enter the details of how much your initial deposit will be, choose your account type from the drop down list, enter your zip code, and choose how you want the results to be sorted. When you get the results back, they will first show you their featured results first (if there are any). Click on the “All Products” tab to see many more options.
Some banks will offer incentives for you to open accounts. Some accounts have requirements such as maintaining a minimum balance or using direct deposit in order to get the good interest rate. Others require a minimum initial deposit. Further, there may be limits on how often you may withdraw or transfer money from the account each month. Remember when you are reviewing these accounts to closely examine the terms for each account offer.
There you have it. My five favorite ways to use my money to earn passive income: dividend ETFs, stock in large cap companies, REITs, Fundrise, and high interest rate savings accounts.
Disclosure:Information shared on Squintillions is based on the author’s own experiences, thoughts, and research and is not intended as professional advice. Please do your own research before committing to any investment! If you feel your personal challenges are beyond the scope of my suggestions or other self-help materials, please seek professional counseling.Further, there are some affiliate links and ads used in this website. If you purchase an item when following these links, I may receive a commission on your purchase.