Chapter 4: Essential Elements of a Passive Income Portfolio

Here are the four essential elements that you should look for in a potential source of passive income:

Security of the source of the passive income

As we have mentioned earlier, passive income is automatically generated with little or no effort required from you after you have made the initial preparations.  You may spend several months to setup your source of passive income but you expect that after that initial work that you do, you can start to wait for the checks to arrive or your bank account to be directly debited with your earnings.  Before you spend your time, effort and money setting up your passive income source, make sure that it is safe and secure enough to automatically generate your income for years to come.  It would really be quite disappointing to expect a check in the mail and it does not arrive.

Potential growth in total passive income you can earn per year

You know that a particular investment is a truly great one when it turns out to be more valuable as the time goes by primarily because the fundamental business model of the company or the fundament value assets is of significant quality that consumers will take continuously take them even the prices also continuously increase.  One good example is an investment in the stocks of The Coca Cola Company.  If you were able to make your initial investments in the 1970’s and held onto those shares up until now, you would have received a number of dividends from the previous years.  But whether or not you chose to reinvest those dividends back into your stock portfolio or not, the dividends that you will receive on your original stock ownership will still be a lot greater compared to those that you received in the previous years because the company itself has grown and its profits have continuously increased and therefore, your shares of stock now warrants more dividends or more earnings.

Diversification of the main assets that enable you to earn the passive income

I am sure you have heard of the old adage “Don’t keep all your eggs in one basket”.  When it comes to your financial investments, you need heed that advice earnestly.  Of course, at the end of the day, you would want to know how much your complete investment portfolio earns for a specific period.  But with everything else being equal, it is a lot less riskier if you can earn an annual income of $50,000 from 20 various investments, which each investment giving you an average annual earnings of $2,500, that risking your funds in just two major investments with the hope that they can generate at least $25,000 each.  If you do not diversify your investments, you run the risk of losing a big portion of your capital when something goes wrong in those few investments.  And you definitely do not want to experience that catastrophe when you have worked for several years in building your investment portfolio only to end up losing a lot of money when you expected to start reaping the rewards of your hard work.

Tax consequence for a particular source of passive income

If you do not like thinking about taxes and tax rates and you just let your employers to compute your taxes and automatically deduct them from your paycheck, you need to change that.  If you truly want to become successful in your financial success, you need to realize that taxes are an important element that you need to start understanding.  It would be quite foolish to count your earnings without taking into consideration the taxes you will have to remit to the government, especially if you have set a target amount for yourself.  Not all the passive income that you earn will have an equivalent amount in dollars.  Currently, dividend income earned from your stock investments is taxed based on a 15 percent tax rate.  On the other hand, a dividend distribution from a master limited partnership may be considered just as a return of investment or capital and you would not have to pay as much tax during the first couple of years.  You can be liable for as high as 41 percent for a traditional corporate bond but you may not be taxed at all for municipal bonds that are tax-free.  But there are certain investment assets that have far more complicated taxation such as those that you hold in specific kinds of accounts like the Roth IRA wherein you are not actually liable to pay any taxes except when you unwittingly fall into traps such as the UBTI or the Unrelated Business Taxable Income Trigger.  When you account for your earnings, ensure that you take into consideration the actual amount that you will get after taxes have been deducted. 

Perform Regular Review of Your Portfolio

You need to instill discipline in yourself if you truly want to achieve financial freedom.  It is not something that you can just wish for and simply wait for it to happen.  You need to regularly perform a review of your portfolio to see which investments are not working for you in terms of their security, growth, diversification and tax implications.  Based on your analysis, you need to create an action plan to increase your chances of success.  Remember, you are the CEO of your own life so you need to act as one.