How to build a portfolio geared for passive incomes

One of the key elements in accumulating wealth and having freedom of choice is passive income. Passive income is money that you make while you’re sleeping, as distinct from active income which is made from personal effort. Passive income comes from holding investments such as property or shares as they grow and generate earnings “passively” in the background.

Over time it is sensible to acquire multiple revenue streams. These may be a mix of active and passive. Your mix of income supports your wealth portfolio keeping it well nurtured and also funds your lifestyle. When faced with a change in market conditions or an economic downturn, multiple income streams have you well prepared as the loss of one income may be backed up by another.  

A major issue that we face as a society is the perception people have around the concept of income. Many people think that income comes from their job. Which it does but your job is simply one active income stream. Unfortunately our wages alone aren’t enough to pave the way to financial security.

COVID-19 has played havoc with a significant amount of people’s incomes. Having sources of passive income can prepare you for difficult times such as this. With passive income comes peace of mind. If your active income is taken away from you, passive income ensures that you won’t find yourself in a desperate situation.

Current times have proven that a healthy wealth portfolio isn’t something we should be planning purely for our retirement years. Your portfolio needs to be carried with you throughout your life and constantly monitored to ensure it is performing at maximum capacity.

A wealth portfolio enhances quality of life ahead of retirement as it presents you with “spare cash” as separate to “necessary cash”. This reduces financial burden and stress. When your active income stops (i.e. your job) your wealth portfolio provides. Finally, when you are gone, your wealth portfolio lives on, leaving a lasting legacy for your family.

Knowing your financial situation – Before you can run, you need to walk

For better or worse, you need to know where you stand with your finances before you can move forward on your path to wealth creation. Your accountant or wealth advisor also needs to know your current position to work effectively with you on establishing and growing your wealth.  

The way I see it is pure logic – you need to treat your personal finances the same way you would a business. Money comes in and money goes out. What is left over is profit or loss, alternatively in a personal sense, surplus or deficit.

When it comes to fast-tracking wealth, and I remind you there is no “get rich quick” formula, we start with understanding the numbers. The secret formula to growing wealth is in your numbers. This is what I specialise in.  

I treat your personal life as a business. I use accounting software to present my clients’ lifestyle in numbers. I work with them to identify their goals, then apply strategy to achieve them. I then monitor performance and tweak as circumstances change. The personal wealth accounting file presents our lifestyle like a business and is scrutinized under profit and loss parameters.

Most of my clients come from a trade background and are dual-income families where the husband runs a business and the wife earns a part or full time wage from an external source. These are the families that tend to do best in the personal wealth zone. 

In some scenarios, the wife lets go of her job to work on the administration of the husband’s business. In the early years of business, it is difficult to generate a double wage and this puts the family under financial pressure. In addition, businesses carry risk and it is sensible to have a backup income from an external source. We like to see both streams contributing to the family unit from a wealth perspective. 

A strategy that we apply often with the dual-income family is setting them up to live on one partners wage. This wage pays for the lifestyle and the business owner’s wage is paid directly from the business to the house mortgage, or if the house is paid off, to an investment mortgage.  

The personal accounting file enables us to understand the family’s cost of living, which is stable year on year. From the numbers, we can determine exactly how much money is required to cover costs. The business owner’s wage is meanwhile building up their wealth portfolio behind the scenes, and they don’t miss it. It just happens.

The more people have access to the more people spend. This is human nature. By diverting one wage, it simply isn’t there for the spending.

Why you need a wealth strategy

Wealth building is goal-based. You start by identifying your goals. Those things in life that you really need and want. A wealth strategy is how you are going to reach each goal. It’s a roadmap. The plan that we implement to achieve your goal. A wealth portfolio holds your combined assets, a mix of investment types, and is nurtured to provide financial security, plus support and enhance your lifestyle.

Remember the adage “Prior Preparation Prevents Poor Performance”? A lot of people overextend because they don’t look at their numbers in the first place, leading them to make really crazy, misinformed decisions. They “fly blind” with their money. 

We often see people who receive an inheritance or a gain where they have sold their family home to access cash from equity growth, and make some serious mistakes with large sums of money. They act on a whim without obtaining advice and it can set them right back. The money disappears as quickly as it comes in on all the wrong things. We also see those whose wealth strategy is to simply do nothing, relying on an inheritance, which is money that may never come.

The key is to be constantly nurturing your wealth profile, monitoring, building, protecting, fixing, improving. Your wealth portfolio brings financial security, enhances quality of life, and peace of mind in uncertain times.

You need to be disciplined in your approach, be very clear on your personal goals. If your goal is simply to “save money” it is unlikely you will achieve it. It’s not enough. Your goals need to be the things in life that you want so much, that there is not a lot that will stand in the way of you achieving them. That’s how badly you want to achieve them.  

My suggestion for practising discipline around saving and growing wealth:

  • Start a personal wealth accounting file;
  • Creatively add or improve income streams, active and passive;
  • Understand your annual cost of living, and shave unnecessary spend;
  • Divert surplus to savings on the day your income arrives in the bank;
  • Identify your personal goals, and break them down into mini goals;
  • Apply your savings strategy to achieving each mini goal.

As an advisor, I understand that telling someone what to do with their money is unlikely to help them succeed at growing their wealth. In our society, due to easy access to debt, if someone wants something they just go out and get it whether they can afford it or not. You can’t tell someone to destroy their credit cards. People are attached to their credit cards and any attempt to question a spending habit is generally met with resistance.  

How we help people with their wealth is by educating them about money. At the end of the day, we can’t change the habits of others. We can’t move in with them or hold their hand. What we can do is help them to help themselves. We do this by demonstrating progress. When a person witnesses for themselves the results of a wealth strategy, the whole process becomes like an addiction.  And fuels itself forwards from there.

By presenting the numbers, and educating on the numbers, explaining what they mean for a person in simple English, and demonstrating performance in numbers, people really start to embrace the concept and take ownership of their own wealth journey.

Within a couple of years, we have people acquiring multiple income streams, culling lump sums from their spending, and paying down their mortgages at high speed. Seeing the progress simply makes them want to achieve more and fast track further. Before long they are into the realms of passive income and their financial pressure starts to melt away. Such reward for all the effort. And a state of mind that only the person can feel when they have achieved it themselves.

Stepping up to hammer down

In this country, debt is very accessible. And not just in the form of bank loans. All kinds of debt. Afterpay, credit cards, vehicle finance. Any debt that is used to fund a lifestyle where you don’t have the cash available to buy something at the time is going to hold you back when it comes to accumulating wealth. “You cannot have what you cannot afford”. It is that simple.

You will never get ahead of the game when you rely on debt funding for lifestyle. The only time we should be using debt is to acquire a modest home, and once paid out, we may use debt to add strong growth assets to our wealth portfolio. This is called “stepping up”.

We step up into assets that appreciate in value such as property, as opposed to assets that depreciate in value such as vehicles and the like. The debt enables us to enter a market that may be otherwise inaccessible to us. Once the debt and the asset is in place we then implement strategy to hammer the debt down, as fast and as streamlined as possible. Our aim is to constantly move our assets into the positive. Once paid out, we step up again.

Over time we present with a string of healthy debt-free investments in our wealth portfolio which feed on each other, accumulating capital growth and passive returns. A very comfortable place to be.

It’s a long game and capital growth is the aim

There is no medal for growing too big, so you don’t need to set out to build an empire. It is about balancing your resources to revenue goals and being realistic. Remember that with any investment there is normally a minimum of 7-10 years holding period for it to be a worthwhile addition to your profile. Each and every investment is a long term decision. You need to have patience to allow your investments time to grow to avoid losses and achieve the best results.

Capital growth should be your number one goal, with rental return and tax breaks being secondary gain. Investments with high rental yields and tax savings alone may be considered in specific circumstances, however, if the property isn’t going to go up in value, it’s a high-risk wealth strategy. Capital growth is number one.

To give yourself the best chance at capital growth, there are some rules of thumb to consider when investing in property:

  • Make sure you understand your numbers, know where you’re at before you do anything.
  • Reach out to your accountant or wealth advisor before you sign anything, get professional advice.
  • Ideally, your accountant or wealth advisor will direct their lending specialist or broker with regard to your lending requirements, in line with your overall financial strategy.
  • Steer clear of advice provided by parties that are not qualified to advise – real estate and buyers agents, banking staff, mortgage brokers.
  • Do your own research thoroughly rather than relying on “word on the street” or the opinions of others.  
  • Make your money on the way in. In other words, buy-in at a price that is not inflated or high premium. Shiny, brand new purchases often carry this tag.
  • Be sensible when choosing your investments. Always focus on capital growth potential. Rental return secondary. And tax savings last (with a few circumstantial exceptions). 
  • If looking into regional areas, choose well established regional centres with employment and industry over remote areas.
  • Let go of the idea of making a quick material buck. Investing is a long term exercise. The more clever your investment choices and the less buy and sell you undertake the better. The contents of your wealth portfolio are long term commitments.
  • Never sit on a mortgage-paying down minimum only to remain geared for tax savings. Consistently work on paying down debt with each addition to your portfolio. As each asset moves towards the positive, “step-up” with debt into your next purchase, and repeat the process of hammering down. Ultimately you want to achieve a debt-free position.
  • The value of property is in the land, not the building.
  • Avoid units and structures where you share with others and don’t own the land.
  • Forget investments where there is low demand and oversupply, this de-stabilises their value and makes them high risk.
  • Investment properties that tend to perform well are where the purchase price is right, the buyer doesn’t overextend, the property is freestanding and in a location that offers adequate employment, industry and infrastructure. Aged cottages on nice sizeable flat blocks, low maintenance in a location that has everything to offer, are a favourite. A cosmetic lift can go a long way with these kinds of additions, with the long term option of development/rebuild.

What about shares?

Advisors will say that it makes sense to diversify. To have a mix of investment types, shares and property, residential and commercial for example. The same applies no matters what the investment type – select strong stable investments with capital growth potential. Investment options for your funds in super are limited to the sharemarket unless you hold a self-managed super fund.

Shares are more easily traded than property obviously and can be a useful alternative if you don’t want to lock funds up in property, being mindful however that the same long term commitment is required for best results. Continuous trade requires material outlays for minimal growth return.

Depending of course on your risk preference, the areas where we see the most returns through share portfolios are once again strong stable investments that tend to withstand times of market instability and present gradual growth over time. Market falls present an opportunity to buy-in. Startups often surprise, but these carry high risk.

If you’re comparing Online Share Trading companies, the comparison table below displays some of the companies available on Canstar’s database with links to the company’s website. The information displayed is based on an average of 6 trades per month. Please note the table is sorted by Star Rating (highest to lowest) followed by provider name (alphabetical). Use Canstar’s Online Share Trading comparison selector to view a wider range of Online Share Trading companies.

This article was reviewed by our Content Producer Isabella Shoard before it was published as part of our fact-checking process.


Leah OliverLeah is a qualified Chartered Accountant, Registered Tax Agent and Public Practitioner, with extensive experience in accounting and finance, from both a chartered and commercial background.  In addition to this, Leah is a wealth educator, putting you, as an individual on the right path to invest wisely. Building a smart wealth portfolio is what Leah wants to teach people. She is the founder of Minnik Chartered Accountants.

 

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