At some point, your paychecks will stop. When that happens, you'll want to have enough headed your way from passive income to cover your costs of living. Especially if you're just starting out on your journey, that can seem like a very daunting goal.
Fortunately, there are plenty of ways to generate cash once you've stopped earning your paycheck. Indeed, there is likely years' worth of passive income, hiding in plain sight. You just need to know where to look and how to plan enough in advance to take advantage of it when you need it.
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Social Security
Most Americans will receive something from Social Security when they retire. Still, it's not an automatic benefit. To receive it, you need to work for at least 10 years in qualifying jobs to get a benefit. In addition, the top 35 years' of your earned income at those jobs go in to determining your benefit level .
While Social Security will provide a decent benefit, it generally only replaces about 40% of the average worker's income. If you earned a higher income throughout your career, it will likely replace less than that, due to bend points and limits on qualifying compensation in its formulas.
Bonds
You probably hear a lot about how higher interest rates make borrowing money more expensive. Fortunately, the flip side of that is that those same higher rates mean bond investors can earn more on the money they lend out.
In a typical bond, the issuer will agree to pay regular interest based on the bond coupon rate, then pay out the face value when the bond matures. As long as the issuer doesn't default on the payment, an investor will receive regular income throughout the life of the bond, then get the bond's face value back at maturity.
REITs
Real estate is a time-tested way to generate regular cash flow from investments. Yet there are two key challenges with directly owning real estate. First, you tend to have to invest a significant amount in each property -- making the pain of failure that much greater if it doesn't work out. Second, being a landlord tends to be at least a part time job, thanks to having to find tenants, collect rents, and deal with maintenance and repairs.
That's where Real Estate Investment Trusts (REITs) come in handy. Those are companies that specialize in real estate. Importantly for income-seeking investors, REITs must pay out at least 90% of their income in the form of dividends. As a result, investors have good reason to believe that as long as the underling REIT remains profitable, some level of dividends should continue to be paid.
Energy pipeline companies
Similar to real estate, energy pipelines tend to be known for their ability to generate and pay out substantial amounts of cash as dividends. This is both because pipelines tend to be fairly low cost ways of transporting that energy for long distances and because a large part of pipeline revenue is guaranteed through "take or pay" contracts.
Of course, there's the potential for a greener energy future to reduce the demand for energy pipelines. Still, the US Energy Information Administration's outlook indicates that future is likely decades away . As a result, today's investors will likely be able to see those cash flows continue for quite a long time to come.
Qualified dividend paying companies
In addition to all those other great ways of generating passive income, many ordinary companies pay dividends. Some even have multiple decades-long histories of increasing those dividends.
Plus, if a company's dividend is considered qualified, investors can even receive that dividend and pay less in taxes on it than if they earned the same amount of money through working . That makes companies with a decent potential of continuing to pay and increase their dividends ones worthy of consideration. Even if their current payments offer a lower yield than these other investments, the possibility of solid growth over time could make them worthwhile.
Keep an eye on the real prize
No matter what set of approaches you take when seeking out your years' of passive income, recognize that there are risks and trade-offs involved with each of these sources of cold, hard cash.
- Dividends are never guaranteed payments.
- Bonds may default, and a constant interest payment may not keep up with inflation over time.
- In addition to the limited payment levels it already covers, Social Security's trustees are warning of likely benefit cuts within a decade if patches aren't made to the program before then.
As a result, it's important to keep an eye on the quality and coverage level of the payments you're setting yourself up to rely on. If a bond or dividend payment isn't sufficiently covered by the company's cash generating ability, it may be at an elevated risk of being cut.
Before such a cut is announced, the company's reported interest rate or dividend yield may be substantially higher than otherwise similar companies appear. Those situations are known as yield traps, and chasing them will very often lead to a portfolio failing to keep up with what the investor needs.
Get started now
Still, with a solid approach that keeps payment quality top of mind and that stretches across multiple of these passive income streams years' worth of passive income may very well be within reach.
It'll take time to build up enough of it, so the sooner you get started, the more of that time you'll have available. Make today the day you take your first steps toward investing in the types of assets that can provide that income stream, and you'll give yourself the most time possible to build a that passive income. As that goal gets closer to reality, you'll very likely be glad you took that first step.
