If you have $100,000 to invest, you can generate thousands of dollars a year in passive income. The type of investment you choose for your $100,000 can determine the amount of passive income you can expect as well as the risk involved and its tax treatment. If the idea of receiving passive income sounds attractive, a financial advisor can help you get started.
Passive Income Defined
The term “passive income” has two distinct meanings. In ordinary use, it refers to money earned without effort. This distinguishes it from money earned by working at a job. Interest on savings accounts, for example, is passive income according to this understanding, while wages, salary, tips, commissions, bonuses and the like is not.
The Internal Revenue Service has another definition. To the IRS, passive income is mostly limited to income received from rental real estate and ownership interests in limited partnerships and small businesses where the owner plays no significant active role. Bank account interest, stock dividends and other income from investments is not passive income but earned income, per the IRS.
The difference can matter if you lose money on something the IRS considers a passive investment. That’s because you can deduct losses from one passive investment to reduce taxable income from a profitable passive investment. This is a minor consideration for most investors, however, so for most purposes the usual understanding of passive income is good enough.
Passive Income From $100,000
The amount of passive income you can earn from $100,000 naturally depends on where you invest it. The most convenient and safest place is a bank savings account. These are federally insured and can offer rates of up to 1.5% a year, equal to $1,500 annually from $100,000. SmartAsset’s savings account comparison tool can help you find the highest-paying savings accounts.
Bank certificates of deposit (CDs) are equally low-risk although less flexible. You can currently get up to 1.75% interest, enough to produce $1,750 in annual passive income, if you are willing to lock up your $100,000 for a year. Longer-term CDs generally pay more.
The securities market is another convenient way to invest $100,000 for potentially more passive income. The S&P 500 is perhaps the most widely used benchmark for investment returns. Over nearly a century, returns from investing in this broad basket of big-company stocks has yielded an average of 10% a year, including dividends and price appreciation. On $100,000, this implies $10,000 a year in passive income, although you may have to adjust this during market downturns.
You can buy individual stocks and bonds at any online or traditional brokerage or bank. The same sources allow easy investments mutual funds and exchange-traded funds consisting of diversified baskets of income-producing securities that are expected to produce more stable returns than individual stocks and bonds.
Note that most experts caution against planning to withdraw 10% a year from your investment account as well as putting everything into the S&P 500. Instead, they suggest a diversified portfolio of 60% stocks and 40% bonds, and an annual withdrawal amount of 4% or $4,000 the first year, with subsequent figures adjusting to account for inflation. The smaller amount cushions against the effects of market volatility and ideally will ensure that your $100,000 churns out passive income for at least 30 years.
If you’re not comfortable investing $100,000 yourself, you can hire a professional investment manager to do the job for you. The investment manager will talk to you about your goals and tolerance for risk, develop a portfolio strategy and handle all the buying, selling and other chores associated with the job. Investment managers can help you earn higher returns and generally charge annual fees amounting to 1% of the amount they are managing for you. Robo-advisors, which skip the human element and automate the job using special software, can manage a portfolio for significantly less, usually about 0.25% per year.
If you want IRS-type passive income, rental real estate is one of the most popular ways to generate passive income. You may be able to purchase a small property in a low-cost market outright for your $100,000. Or you could your cash as a down payment on a pricier property. Using a couple of rules of thumb for rental real estate, a $100,000 property could generate $1,000 a month in rent, of which you can expect half after operating expenses ($500 a month or $6,000 a year).
Putting all your passive income eggs in one real estate property basket can be too risky for many investors. A more diversified option is to invest in shares of a publicly traded real estate investment trust (REIT) that owns a large number of properties. A broad index of US REITs historically has produced widely varying annual total returns that averaging almost 12%, so $100,000 invested in REITs could generate about $12,000 a year in passive income.
Royalty income meets the IRS passive income definition and is available by purchasing shares in publicly traded royalty trusts or bidding on royalty exchanges. Oil and gas fields, films, music, books and more all can generate royalties. The amount of income varies widely but tends to be stable and predictable.
Bottom Line
Passive income that requires no effort by the investor is available from a wide variety of investments ranging from ordinary savings accounts to oil and gas royalty trusts. Passive investments that have little risk pay the least, while passive income from riskier investments like the stock market pay the most. An investor with $100,000 can potentially expect anywhere from $1,500 to as much as $12,000 a year on average from passive investments that will require little or no effort to oversee.
Investing Tips
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A financial advisor can help you create a passive investment portfolio that meets your needs. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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If you are looking for other sources of income, here are five ways to generate guaranteed income.
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Source: finance.yahoo.com