FIRE up your passive income!
In an article from evajinek.nl, the seemingly endless possibilities of passive income are discussed. One of the ‘hot’ topics concerning passive income, is FIRE: financially independent, retire early. Why are people considering this option more than ever and what are the best ways to start earning a passive income? Patrick Verwijmeren, Professor of Corporate Finance at Erasmus School of Economics, gives his opinion on the subject and some recommendations.
Since the COVID-19 pandemic, many people have come to realise that life is sometimes more unpredictable than one might expect. People lost their jobs, and therewith instantaneously their only source of income. With rent due, it is nice to have a stash of cash at hand. Some people even dream of waking up after a good night of sleep, having earned their month of rent unconsciously. However, Verwijmeren points at the risk that is inherently a part of earning passive income: ‘It might be too simplistic to think that people get rich in their sleep. You take risks as well when earning a passive income’.
By spending less than you earn, it is possible to set aside some money to invest. By doing this in a disciplined fashion, these amounts, if invested, can add up to a nice retirement. Verwijmeren emphasises the importance of diversifying risk: ‘if we look at finance theory, diversification of investments is an essential cornerstone. This not only applies to investments, but sources of income as well’. A clarifying example is the process of writing a book. Since it is impossible to be certain of its return, it is sensible not to spend all your time writing the book: ‘if you want to lessen your risk, it is better not to put all your eggs in one basket’. This is, of course, just one of the many possible ways to earn a passive income. For instance, people make online courses or spend their time in another way. But the most effective way to earn passive income is by investing money instead of time, to really make earnings independent of time. However, don’t expect to become rich overnight: ‘it is an income source for the long term. In the beginning, it is impossible to live off your investments. You invest money now to reap the benefits in the future’.
Trackers or active investing?
If you are willing to invest time in your investments nevertheless, it is best to start your journey by learning via a so-called shadow portfolio. Verwijmeren: ‘you don’t really buy shares, but you are able to see what would have happened if you did. In this manner you can try all sorts of strategies, which is a lot of fun’. You do bear a lot of risk: as an uneducated investor, active investing bears a strong resemblance to roulette. Because of this, Verwijmeren recommends buying trackers, also known as ETFs. ‘If you buy a tracker, you effectively buy the AEX or another index as a whole, but comprised in one share. Your share follows the index. This is an efficient way of starting on the stock market and your investment is diversified, since it follows an index’. It is also possible to buy ESG trackers, which is a new development in the financial world. ESG (Environmental, Social and Governance) trackers are sustainable ETFs.
In addition to investing on the stock market, it is also possible to diversify your investments by investing in other options, such as gold, art and real estate. By balancing your portfolio with investments that move in opposite directions when the market changes, you bear less risk. An example of this is the antagonistic relation between bonds and stocks: historical data shows that stocks tend to be booming when bonds are low, and vice versa.