What types of income do financially independent people rely on to support their lifestyles? Contrary to earning income from a job, for which you have to be present and make a significant effort, passive income refers to anything that generates money for you without you having to lift a finger…or almost.
The challenge for small and medium-sized investors is to build something that allows them to live off this type of income. In other words, to jump into the big leagues!
Real estate: rolling up your sleeves to take advantage of the lever effect
Real estate is one of the most-cited ways to get rich in various books about financial independence. This was the strategy of the famous author of Rich Dad, Poor Dad. For fans of HGTV and other home improvement shows, flipping an old bungalow may be for you. However, the majority of investors are turning to income properties. Here are two possible ways to generate passive income through real estate, although there is a wide variety.
In the first scenario, you buy a house or condo for yourself, ideally with a large down payment (20% to avoid paying for CMHC insurance). You repay your capital as quickly as possible with large, accelerated payments and annual remittances. During this time, tour some neighbourhoods and cities that have good economic potential. For example, a city could initiate major economic development linked to a large industrial project. A building that doesn’t look that great will have excellent potential for optimization, with some renovations on your part. You then refinance your existing property to free up the funds necessary to acquire an income property in that location. A fourplex or a six-unit building could generate over $40,000 per year, depending on its location and condition.
In the second scenario, you adopt the tough guy technique. Buy a building before owning your own home. You will only buy your own home when you have created enough passive income to cover the price. In this case, a first purchase, say a triplex, can be refinanced to acquire 12 units or a semi-commercial building. This should generate a more than respectable amount. Whether you prefer either of these scenarios, you can always sell at a convenient time, such as now, when it’s a sellers’ market.
Are you the kind of person who isn’t afraid to get your hands dirty and already have the funds to invest in real estate? Learn about the rules governing the purchase of income properties, remain vigilant and surround yourself with professionals.
Dividends: passive and constant
To increase their net worth, followers of the FIRE movement often choose to invest in the stock market in growth-oriented funds and don’t touch that money for a long time. What do you do when you want to immediately benefit from the money generated by your investments? You can either dip into it day-to-day, or think of a strategy to stabilize your profits.
Several types of exchange-traded funds (ETFs) invest in companies that pay dividends on a monthly or quarterly basis. There are also real estate investment funds that pay dividends, for those who aren’t interested in replacing toilets. In exchange for relatively low fees, these funds can diversify your portfolio. For example, banks are notorious for paying dividends. But ETFs are very popular with FIRE enthusiasts, and it’s for good reason. They represent the ultimate in passive investing, requiring very little time on your part to manage them. It’s even better if they’re saved in a tax-free account, like a TFSA! From iShares to Vanguard, there is a certain choice of Canadian dividend ETFs that pay a 3-5% return, in addition to other industry and global ETFs.
If the high passivity of this type of income appeals to you, learn about dividend-oriented investing and its applicable taxation.
Government benefits? Beware, it’s a hot topic!
The FIRE movement’s superstars sometimes share their stories in the newspapers. And it is inevitable, as the social networks are on fire! Why? Because their low retirement income often gives them access to government programs set up to help middle and low income people. Assets are not taken into account in this type of calculation. The fact that they have substantial assets while receiving certain credits generates a certain social unrest. However, claiming certain credits can remain a personal choice; they may or may not be part of your strategy.
Once you “retire”, by keeping your taxable income as low as possible, not only will you pay very little tax, but you will maximize your refundable tax credits. Some examples are the federal GST/HST credit, the Quebec provincial solidarity tax credit, and family allowances. If you have children, several thousand dollars are potentially on the table for you! In addition, as of the age of 60, the amount you must generate in passive income will decrease, since you’ll be eligible to receive benefits from the Quebec Pension Plan and the Old Age Security Pension.
In order to determine if your projected passive income will be sufficient to cover the majority of your expenses, you must first know the total amount of these expenses, calculate your FIRE number and apply the 4% rule. They are explained in this article about the basics of the FIRE movement. There is no single passive income recipe for financially independent people, because each FIRE superstar has their own disbursement plan and your personal situation will probably be just as unique as theirs.