The ability to acquire income generating assets is an essential part of achieving financial independence. If you can generate enough income from your savings, investments and business ventures, you can effectively ‘retire’ from the 9-5 grind of every day employment.
For many people, this might seem like a pipe-dream, but it’s a serious goal of mine. Starting in my early twenties, I investigated as many options as I could for achieving it. It quickly became apparent that I wasn’t the only one who was in pursuit of this goal.
Building a portfolio of income generating assets is more difficult than it sounds. Managing the requirement for regular and stable cash flow with the requirement for capital protection and growth is essential for long term stability.
Professional wealth managers will stress the need for diversification to reduce volatility, but too much diversification could provide an insufficient hedge against inflation. The key to surviving from your portfolio is to generate sufficient income to avoid touching the capital. Consequently, some investors purchase shares solely for their yield, building a portfolio with unstable returns and high volatility.
If you like the sound of ditching the 9-5 grind, but don’t know where to start, you’ve come to the right place. Learning about income generating assets will help you start your journey, and whilst this list is hardly inclusive of all possibilities, it provides a quick guide to some of the available options.
Property – we’ve all heard of the benefits of investing in real estate, and it can certainly prove to be a great source of income. Essentially, you purchase a home and rent it to a tenant. Each month, you tenant pays rent for the right to inhabit the property. Once you’ve paid off expenses such as maintenance and a mortgage, any money left over is cash to keep.
As you pay off the mortgage, you’re also increasing your equity the property, potentially providing some measure of capital gain over the long term.
Owning property doesn’t come risk-free however. Irresponsible tenants can cause damage to the property, and if you have a period with no tenants at all, you’ll be left to pay the mortgage on your own. In addition, if your lender decides to put up the interest rate on your mortgage, you could quickly find yourself losing money, with the rent failing to cover costs.
Similar to residential property but usually with a higher value and different clientele. Commercial property comes in the form of real estate designed for business use. Whilst you can nearly always charge higher rents, the value of these properties is much higher (regularly upwards of £1,000,000).
Like residential property, these investments represent significant risk if the tenant begins to struggle. Whilst a business needs staff and stock, they won\’t hesitate to cut out expensive offices when cash flow becomes a problem. With the rise of virtual meeting and remote working technologies, many businesses are also questioning the need for expensive city-centre locations.
Real Estate Investment Trusts (REITs)
A good method of investing in property without directly owning it. Real Estate Investment Trusts, or REITs, are a great income generating asset. A corporate structure designed to invest in a portfolio of real estate, REITs pay out profits on income and capital gains from holdings. Although not guaranteed, REITs provide an investor with a regular and reasonably consistent income. To find out more, read my article on investing in these vehicles.
One of my first ever investments was a dividend stock. These are companies with strong cash flow, low debt and diversified product lines that pay dividends every quarter. Although not a ‘monthly’ income generating asset, dividend stocks still provide a reasonably secure investment for generating passive income.
Investing solely for income is usually a recipe for disaster, as if the company goes bankrupt, you stand to lose your capital. Always ensure that you carry out sufficient due diligence before pursuing such an investment.
Another opportunity I pursued early on, P2P lending is a great way of attracting good rates of return. Having invested since 2010 with Zopa Loans, I’m yet to have a loan go bad. Admittedly, I attribute this more to luck and the relative size of my investment than expertise, but I still consider this a low risk opportunity.
Essentially replacing middlemen such as banks, P2P platforms like Zopa allow an investor to lend directly to borrowers. In order to provide a degree of security, borrowers are categorised with a letter to represent their rise. For example, if you’re willing to take significant risk, you could lend into the ‘D grade’ market of individuals with no credit rating. If you’re less willing to incur losses on your loans, you might stipulate that your funds only be lent out to ‘A grade’ borrowers – those with strong and stable credit ratings.
Splitting your money between multiple borrowers greatly reduces your overall risk. For example, I stipulate that no more than £10 is to be lent to any individual. This means that for every £100, I’m making at least 10 individual loans.
This industry is still relatively new, and consequently has had some bad coverage over the last few years. Personally, I believe this will settle down over time, and so continue to lend through the platform. As with all the options on this list, make sure to do your due diligence before proceeding.
Bonds are one of the most boring (and overlooked) forms of investment. When a company or government wants to borrow money, they issue a bond on the market to raise the capital. These income generating assets are therefore essentially a loan. You give the borrower a sum of money, and they agree to pay you back (with interest) after a certain period of time.
Typically seen as being very low risk, these investments can be a good source of stable income. Don\’t assume that your capital is secure; there are risks inherent in this business.
For example, lenders to Argentina recently got into hot water when the Argentinian economy hit a severe recession. The collapse in tax revenues and increasing demands on the state became unsustainable. As a quick fix, the government decided to let the country default on more than $90 million dollars of debt. This wasn\’t just debt held by rich institutions either, and affected retail investors around the world.
When a group of investors pool their capital for mutual benefit, you have a mutual fund. Although these investment vehicles often come with high costs, they can produce a regular income if well managed. Although not a bad starting vehicle for investors, I’m not a fan due to high costs and generally poor performance. Having said that, I recognise that they suit the requirements of many investors, just not my own. You can find out more about mutual funds in my article here.
Exchange Traded Funds (ETFs)
An exchange traded fund, or ETF, is an investment vehicle which tracks a certain commodity, index or collection of assets. Unlike mutual funds, an ETF is traded like a stock, with prices rising and falling with demand. As they simply track an index or asset, the associated fees are much lower than mutual funds, and are an easy way of diversifying an existing portfolio.
As a shareholder of an ETF, you are entitled to a percentage of any profits such as interest or dividends, and can get a special dispensation in the case of liquidation.
Secured private lending
There is no shortage of people looking for a loan. Entrepreneurs and small business owners often can’t (or don’t want) to get loans from their banks. This allows a market for private lenders to step in and provide much-needed capital for start-ups and growth seekers.
In return for your cash, you can charge interest, making a private loan a good income generating asset. The ‘secured’ part comes from including a claim in your agreement against an asset owned by the borrower. These assets might include a house, car or jewellery. If the borrower is unable to make repayment, you take possession of the asset to cover your loss.
Unsecured private lending
Of course, not everyone owns assets to secure as collateral. Although riskier, it is possible to lend to these borrowers, who are usually charged higher rates of interest. This type of loan can be an excellent income generating asset, but if the borrower defaults, you could incur significant losses.
Additionally, if the borrower has taken out ‘secured’ loans, in addition to yours, those lenders will likely have first priority for repayment. Consequently, I try to avoid unsecured private lending wherever possible.
Conclusion: the power of income generating assets.
Clearly, this is not a definitive list of income generating assets available to you as an investor. It’s essential to do your research, diversify your holdings, and if needed get professional advice before handing over your money. Taking consideration of tax implications and liquidity are just two of the many things which an investor needs to consider as part of their broader investment strategy.
The acquisition of income generating assets as a method of building wealth is preferable to me over trying to determine which assets might benefit from capital gains. Rather than analysing (or hoping) that your assets increase in value, income generating assets allow you to comfortable enjoy a more constant and predictable revenue from your investments.