Right now I have 50k/no debt and I am trying to build up a passive income. I need something that will generate me around 5k a year. I'm a little scared and don't know much about investments. I'm looking for something that is relatively low risk. I appreciate any advice that I am given. Hopefully I can build up a good enough passive income so I don't have to worry about life as much.
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1Please elaborate on "build up"... do you mean the 50k is just a starting sum and you will add to it with further savings? Or that you want to grow just this 50K to the point that it can generate 5k income at some point in the future? (I assume it's obvious to you that expecting a 5K pa return on 50K alone is a 10% rate of return, which would probably mean going to the junkiest of junk bonds these days... certainly not "relatively low risk")– timdayOct 14, 2016 at 12:31
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1I think you need to provide more details. Mainly: why? Are you a recent widower that has a 50K life insurance policy? Are you physically disabled and received that amount as a settlement? Do you have that much and just want to live abroad without working? These are all different answers. Please include your ability to work and expected salary for the best answers.– Pete B.Oct 14, 2016 at 13:16
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2Give us an assessment of how much risk you're willing to take. Think about your age and how willing you are to tolerate short term losses. As you've asked your question, it can be answered in many different ways but many of them won't be good for you depending on your attitude to risk.– mathemagicianOct 14, 2016 at 13:27
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9One fairly conservative rule of thumb is that, for passive income, you should figure on 4% annual return as being low risk over the long term. So $50k should be a good basis for $2k/year, not $5k.– keshlamOct 14, 2016 at 14:55
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2Also, when will you need that income? The longer you can let the money grow before having to start using it, the more you'll be able to take when you do start using it. (Modulo some risk.)– keshlamOct 15, 2016 at 3:45
1 Answer
Unfortunately, in this market environment your goal is not very realistic.
At the moment real interest rates are negative (and have been for some time). This means if you invest in something that will pay out for sure, you can expect to earn less than you lose through inflation. In other words, if you save your $50K, when you withdraw it in a few years you will be able to buy less with it then than you can now.
You can invest in risky securities like stocks or mutual funds. These assets can easily generate 10% per year, but they can (and do) also generate negative returns. This means you can and likely will lose money after investing in them. There's an even better chance that you will make money, but that varies year by year. If you invest in something that expects to make 10% per year (meaning it makes that much on average), it will be extremely risky and many years it will lose money, perhaps a lot of it. That's the way risk is. Are you comfortable taking on large amounts of risk (good chances of losing a lot of your money)?
You could make some kind of real investment. $50K is a little small to buy real estate, but you may be able to find something like real estate that can generate income, especially if you use it as a down payment to borrow from the bank. There is risk in being a landlord as well, of course, and a lot of work. But real investments like that are a reasonable alternative to financial markets for some people.
Another possibility is to just keep it in your bank account or something else with no risk and take $5000 out per year. It will only last you 10 years that way, but if you are not too young, that will be a significant portion of your life. If you are young, you can work and add to it.
Unfortunately, financial markets don't magically make people rich. If you make a lot of money in the market, it's because you took a risk and got lucky. If you make a comfortable amount with no risk, it means you invested in a market environment very different from what we see today.
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To get an idea of what risk free investments (after inflation) earn per year at various horizons see this table at the treasury. At the time of this writing you would have to invest in a security with maturity almost 10 years in order to break even with inflation. Beating it by 10% or even 3% per year with minimal risk is a pipe dream.
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2Many folks here would disagree with this bleak assessment. Long-term market rate of return continues to be sufficiently above inflation -- in the US, anyway -- to make a simple differentiated index fund assortment quite worthwhile. Investing won't make you rich all by itself, but it will probably make money at a reasonable rate with very little effort. Trying to chase higher returns is what gets people in trouble; those come with higher risks.– keshlamOct 14, 2016 at 17:10
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1No question that diversified investments can make money (I invest, as should most people) but with significant risk. The OP wasn't clear about the definition of "low risk" but a zero risk portfolio earns certainly less than inflation. Long term fixed income investments bear significant risk of losing value if inflation or interest rates rise. I agree that risky securities have a good chance of making money (though the chance of beating 10% is questionable) but they also have a good chance of losing money, which is what I warn about.– farnsyOct 14, 2016 at 17:15
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1Zero risk is indeed unreasonable, but fairly low risk can still yield long-term estimated returns above 6%. My long-term average is around 10%, but part of that was during a boom period and part of it was during the recent unpleasantness so I'm certainly not claiming that would be a typical result... And that has to be de-rated rather severely if you're talking about using it to fund a fairly reliable passive income stream. And again, I'm talking about long-term investing with time for swings to average out.– keshlamOct 14, 2016 at 17:27
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I know this asset manager that "shorts the fed funds futures to lock in an interest rate and buys bonds w/ an average annual yield of 5% on 3.3x leverage" for passive income of 13%. A wave of defaults on a basket of corporate bonds at those ratings would be new. I thought it was an interesting approach.– CQMOct 14, 2016 at 17:44