Active income, also known as earned income, is defined as wages, salaries, tips or bonuses earned from doing a job or providing a service. The average tax rate on active income varies from 10% to as much as 37%, depending upon your income level. Passive income, on the other hand, requires only minimal labor to be maintained. An example of this would be income resulting from profit distribution from a limited partnership interest in a firm, book or music royalties, rental payments and cash flow from investments. The tax rate on passive income is generally in the 10% to 15% range.
Portfolio income is considered to be a form of passive income that is specifically derived from the ownership of financial instruments. Portfolio income is subjected to a tax rate of up to 20%.
Interest – Let’s say you have a traditional savings account, a money market account, a certificate of deposit or a bond. The interest payments you receive in exchange for lending your money are considered portfolio income.
Dividends – As a shareholder in a publicly traded company, you may receive a dividend under a certain set of circumstances. As an example, if you own 100 shares of the Alpha Bravo Charlie Corporation, and the company decides to pay a dividend of USD 1 per share, you’ll receive a USD 100 dividend payment.
Capital Gains – Now, let’s say you’ve decided to sell your 100 shares of Alpha Bravo Charlie, which you purchased at USD 5 per share. On the day of the sale, Alpha Bravo Charlie is trading at USD 20 per share. The USD 1,500 profit (USD 15, times 100 shares) is considered a realized capital gain, which also has a special taxation regime in the US.
Any long-term investment strategy should have beating inflation as its main goal. As company earnings tend to reflect increases in prices, equity investments are seen as a traditional hedge against inflation, through both dividends and capital gains.
The main potential downside of equity investments is short-term market volatility. Diversifying your portfolio with bonds may help achieve more steady returns through fixed income interest payments.
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Step 1 – The first step toward earning portfolio income is to determine how much monthly income you’d like to earn from your portfolio. Other relevant questions that can help framing the issue are how the portfolio income will be spent, if it is intended to cover part of your monthly expenses. You also want to determine the timeframe of your income needs.
For instance, if you do not have immediate liquidity needs you can have access to higher yielding products by harnessing duration.
Step 2 – The following step is to choose a targeted yield for the portfolio, which should reflect your needs. That, in turn, will help you figure out where to allocate your money to increase the likelihood of realizing that goal.
Your target return will help you determine how much money you need to invest, over what time horizon and the type and mix of investments to include.
A 5% return on a USD 1000 investment will earn you USD 50 annually. Typically, higher potential returns reflect higher risk, though there is scope for identifying investment opportunities where this risk is mispriced – for instance, if most market participants are overestimating risk. This is why due diligence is extremely important in both private and public markets, but tougher in the former as there is more limited public information.
Step 3 – When it comes to choosing your portfolio asset allocation, there is a wide range of asset classes from which to choose. These include savings vehicles such as certificates of deposit, savings accounts and money market accounts, as well as bonds, loans, dividend-paying stocks, preferred stocks, and REITs. There are other investment vehicles which can be a combination of these instruments, such as mutual funds and ETFs.
Each one of these assets has a different risk-return profile, and an investor should determine if it is an appropriate choice for his portfolio given the return requirements and his/her willingness and ability to withstand volatility.
Allocations to alternative investments can help diversify your portfolio, and obtain passive income from assets that are less correlated to public markets.
Step 4 – Now that you’ve determined how much you would like your portfolio to return on an annual basis, and you’ve established a targeted return and chosen the assets you want to include, it’s time to figure out how much cash you need to invest.
For instance, for a monthly income of USD 5000 – USD 60,000 annually – if your target return is 5%, you’ll need a USD 1,200,000 portfolio to generate that return.
Step 5 – It is critical to get into the habit of reinvesting part of the portfolio income received along the way. This will enable you to harness the power of compound interest. It is also a good idea to keep investment costs low – by, for instance, avoiding frequent day trading – as excessive costs tend to eat up returns.
Yieldstreet’s offers seek to generate income by investing across private asset classes such as art finance, commercial finance, consumer lending, legal finance, real estate, and corporate finance. Sign up to Yieldstreet’s platform and start investing with a minimum of USD 500.
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