Late last year I shared a post with you guys on increasing the GYFG household income to $600,000 annually, and in that post there were two concerns that I said I wanted to start addressing in 2017:
- Concentration Risk – In 2016, approximately $27,000 of the $340,000 that we earned came from passive sources (or about 8%). The majority of the income we brought in was from our day jobs.
- Tax Efficiency – The other problem outside of the concentration risk, is that with earned income, we are taking a beating when it comes to taxes. As we all know, earned income is not the most tax efficient, and based on our 2017 projected income our marginal tax rate federally is going to be 33% and 10% for state (this is on top of FICA, Medicare, and CA SUI/SDI).
In order to address both of these issues, I have decided that it is finally time to start focusing on building up our passive income sources. As a first step, I have put together two new tabs in my master Excel spreadsheet, one will help me keep track of our dividend portfolio, and the other will help me keep track of all of our passive income sources.
I am a big believer of the saying “in order to know where you’re going, you have to know where you’ve been.” So, let’s take a look at the current state of our passive income as of December 2016.
Current Passive Income Streams
To be honest, after I finished pulling all this together, I was actually pleasantly surprised to see where our baseline was. A gross amount of ~$27,000/year is a respectable amount, yet we still have a long road ahead of us to get to $120,000/year.
We have been tracking our expenses in detail for 3 years now (2014 to 2016), and our annual spending has landed in a range of $110,000 to $120,000. Keep in mind that this does include the cost of the mortgage for our rental, our home mortgage, and costs for home improvement projects (only a few projects left; we tackle one a year). All of which we plan to eliminate from our budget all together over the next 5 years.
Eliminating those 3 expenses, will free up ~$48,000/year, which we will then re-allocate to other spending categories, one of which will likely be travel. All of this to say, that $120,000 should give us a very large cushion above and beyond our annual cost of basic living (defined by our own standards).
Let’s not pass over the fact that eliminating expenses is also another form of creating what I like to refer to as phantom passive income.
Filling The Gap From $27,000 to $120,000
Back to business.
We currently have an additional $93,000 of passive income to create and there are so many options to choose from in order to reach our goal. Let’s take a look at how much additional capital we will need to put to work at different yields in order to quantify how much we will need to invest:
3% Yield= $3,100,000 – This is probably pretty easy to achieve by constructing a stock dividend portfolio. This will mostly be focused on in our retirement accounts.
5% Yield = $1,860,000 – This could be accomplished with the right mix of corporate bonds or even in rental real estate here in California. I have actually run some numbers based on our primary residence and this is about the cash on cash return we could expect to earn currently if we turned our place into a rental.
8% Yield= $1,163,000 – My new favorite asset class is in the debt portion of the real estate equity stack. Also known as hard money lending. Through PeerStreet I have found the ability to access this market at scale and with diversification and huge downside protection. This is an asset class I have already put $77,000 to work in 2017 (over about 43 investments).
15% Yield= $620,000 – I have seen others online achieve 15% + cash on cash returns investing in out of state rental real estate. Not going to find this in my home state of California. Although this is very alluring, my wife and I are really growing fond of the online platforms. At some point we will be ready to take on some more leverage, the timing just isn’t right for us yet.
This list is obviously not exhaustive, but it is the spectrum of yields and investments we intend to pursue in order to build up to our income goal. My gut says if we set this up correctly, we will likely end up investing about $2,000,000 in order to fill our gap (representing a 6% blended yield).
As a result of this new focus I will be periodically sharing a detailed breakdown of our passive income sources, like the table above.
What sources of passive income do you have? Do you have a goal that you are shooting for? What of some other ideas you can share to generate higher yields?
– Gen Y Finance Guy
Personal Capital allows you to aggregate your entire financial life into one account. All you need to do to see all your accounts in one place is log in to Personal Capital and voila! But it doesn’t stop there. They even automatically classify all your income and expenses for you. You get a FREE and fully AUTOMATED tracking system!