My top financial goal is to achieve financial independence. That would allow me to retire early if I choose. It's not that I don't want to work anymore; I just don't like the stress of relying on my income from work to cover my living expenses. As artificial intelligence's (AI) capabilities continue to improve, I can see the writing on the proverbial wall for my profession.
However, unlike many people following a FIRE (Financial Independence, Retire Early) strategy, my wife and I don't want to cut our living expenses to the bare bones. While we're pretty frugal, we also want to live comfortably. That's why I'm focusing on building my sources of passive income instead of trying to accumulate a large amount of assets (e.g., FATFIRE).
I also don't want to have to sell my investments when they're down to cover my living expenses. I want to rely on my recurring passive income to fund my basic financial needs.
Here's how I'm building financial independence through passive income.
Image source: Getty Images.
The power of dividend stocks
The foundation of my FIRE strategy is investing in high-quality, dividend-paying stocks. I focus on companies that steadily increase their dividends because they have historically produced the highest total returns. Over the last 50 years, dividend growers have produced an average annual total return of 10.2%, according to data from Hartford Funds and Ned Davis Research. For comparison, companies that don't change their dividend policy have only delivered an average annual return of 6.8%.
I primarily invest in companies that pay steadily rising, higher-yielding dividends backed by strong financial profiles. For example, one of my core holdings is Realty Income (O -0.09%). The real estate investment trust (REIT) currently has a dividend yield of around 5.5% -- well above the S&P 500's (^GSPC 0.83%) sub-1.5% yield. The company backs its payout with a high-quality real estate portfolio (retail, industrial, gaming, and other properties secured by long-term net leases with the world's leading companies).
Realty Income pays out a conservative percentage of its stable cash flow in dividends (75% of its adjusted FFO). It also has one of the strongest balance sheets in the sector. The company's fortress financial profile puts its high-yielding dividend on a rock-solid foundation. It also gives the company the flexibility to expand its portfolio and increase its dividend.
Realty Income has increased its monthly payment 131 times since its public market listing in 1994. Its high-yielding and steadily rising dividend has enabled it to deliver fantastic total returns since its listing (13.6% annualized).
Investing in high-yielding dividend stocks, such as Realty Income, enables me to generate more passive income from every dollar I invest. They also steadily grow my passive income without me needing to add to my investment. They should enable me to reach my passive income goal sooner.
Passive income from ETFs
I complement my stock portfolio by investing in exchange-traded funds (ETFs) that focus on income generation, primarily using ETFs with bonds, preferred stock, and option strategies. I've found that it's easier to invest in an ETF to earn income from those asset classes rather than trying to manage those investments myself.
For example, while I do trade options to generate income, I've found that investing in an ETF like JPMorgan Equity Premium Income ETF (JEPI 0.26%) is a great complement to my options income strategy. The fund writes (shorts) out-of-the-money (above the current market price) call options on the S&P 500. This strategy generates income that the fund distributes to investors each month.
That income stream can be very lucrative:
Data source: JPMorgan Asset Management.
The JPMorgan Equity Premium Income ETF also has an underlying portfolio that provides less volatile exposure to the stock market. As a result, the fund offers both growth potential and income.
Private real estate and credit
A third aspect of my passive income strategy is alternative investments that generate income. I primarily invest in private real estate and credit investments. I like adding some private market exposure to increase my diversification because the value of these investments doesn't move in direct correlation with the public stock and bond markets.
For example, I invest with Fundrise, the largest direct-to-consumer private market manager. Fundrise enables anyone to invest in private real estate, private credit, and venture capital. It offers a low minimum investment (just $10 in a taxable account) and very low fees. Fundrise's private real estate investment funds hold income-generating assets (build-for-rent communities, multifamily apartments, and industrial properties) that produce rental income that the fund distributes to investors.
Building financial freedom through passive income
I want to become financially independent, which I'll achieve once my passive income can cover my basic living expenses. I make steady progress toward my goal by investing some of my income from working and the passive income I produce into income-generating assets. My goal is to achieve financial independence through passive income within the next five years.
