Everyone has their own magic number. The amount of passive income they'd need to generate to cover their annual expenses and achieve financial freedom. For the average person under 65, that's around $84,000 per year, according to The Motley Fool's report on the Average Income for Retirees in America.
Some investments enable you to generate more income than others, putting you closer to reaching that magic number. One of those is Energy Transfer (ET 1.01%), which currently offers investors a monster income yield at 7.5%. That's several times higher than the S&P 500, which currently yields around 1.2%.
Here's a look at whether the master limited partnership (MLP) -- which sends investors a Schedule K-1 Federal tax form -- can generate enough passive income to set you up for life.
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The math to financial freedom
Covering $84,000 in annual expenses is no easy task. Using the common 4% rule, you'd need to amass $2.1 million to safely withdraw $84,000 each year to avoid running out of money in the future.
However, that assumes you withdraw both the principal and the income generated by your portfolio. An alternative strategy is to build an income-focused portfolio that would enable you to cover your annual expenses with passive income alone, leaving the principal untouched.
For example, Energy Transfer currently pays its investors $0.335 per unit each quarter ($1.34 annualized). At that rate, you'd need to own 62,687 units of the pipeline company to generate $84,000 of passive income each year. That reduces the required investment to around $1.1 million at the MLP's current unit price of $18.
NYSE: ET
Key Data Points
Factors to consider
It's certainly possible to invest enough money into Energy Transfer to generate sufficient passive income to set yourself up for life. However, $1.1 million is still a lot of money. Further, it would be highly risky to rely on a single investment to meet your income needs. If Energy Transfer were to reduce its distribution payment (which it did in 2020), you'd face a potentially significant income shortfall.
On a more positive note, the risk of a future distribution cut is lower today than it was in the past. Energy Transfer is in the strongest financial position in its history. The MLP generates very stable cash flow, as about 90% comes from fee-based sources, such as long-term contracts and government-regulated rate structures. Meanwhile, the company currently pays out a little more than half of its stable cash flow, retaining the rest to reinvest in the partnership. Those investments should grow the MLP's cash flow, supporting its plans to increase its distribution by 3% to 5% per year (it has raised its payout by over 3% in the last 12 months).
One part of the solution
Investing in Energy Transfer alone likely won't set you up for life in passive income. You'd need to invest a significant amount of money in a single stock, which would be very risky.
However, the MLP could certainly be part of your financial freedom strategy. Investing in the MLP as part of a diversified income portfolio could enable you to generate a growing stream of passive income. You could reinvest that income into additional income-generating assets until you eventually reach your magic number for financial freedom.
