Ahh making money while you sleep… it’s the dream of every working human (no pun intended).
To have the choice to work or not work and have cash coming through the door regardless is really what retirement is supposed to be about. Whether that happens at 65, 40 or 25 is the question that most people debate when it comes to passive income.
For most of us, our current system of 9.5% compulsory superannuation (plus assistance from the Age Pension) is enough to arguably sustain a comfortable retirement once one reaches the age of 65–70. However, most of us who invest hope that doing so will allow an earlier retirement, if we so wish.
If you ask your average person on the street on their thoughts on passive income, you will probably hear about ‘drop shipping’, online businesses, affiliate marketing or ‘something on Amazon’. I’m not casting dispersion on any of these paths, but there is an easier way to aim for ‘money while you sleep’.
According to reporting in the Australian Financial Review (AFR), the easiest and most common way to make passive income is indeed through investing – more specifically by following a series of key steps. It’s by following these steps that the AFR reckons the wealthiest 49% of American households use to build wealth. I’ve summarised them below.
Step 1 – Consistently saving 20% or more of your income and investing your savings over the long term.
This forced frugality allows you to consistently set aside money for your future. It’s not enough to have your money sitting in a savings account either – with interest rates at record lows, you really do have to go beyond the confines of your CommBank app to get real bang for your bucks these days.
Step 2 – Create goals
Having goals helps you focus on what you’re really saving for. Whether is simply an early retirement or a university fund for your kids, having a set goal or goals makes it easier to stick to your plan.
Step 3 – Limit your spending
The old saying of ‘a penny saved is a penny earned’ has never had more relevance. Every dollar you save by not forking out on a expensive car or that nice set of jeans is another dollar you can invest, so think twice before you next ‘treat yourself’ – $1 today could be worth $10 down the road.
Step 4 – Invest in an index fund
This is an important one. Most investors who try to pick shares right off the bat often end up losing money – or worse, getting put off investing altogether. By just buying cheap index funds like the Vanguard Australian Shares Index ETF (ASX: VAS), you are insuring a market-matching return with almost no effort.
Step 5 – Invest regularly
As everyone knows, the share market can have really good days, and even worse bad days. By investing consistently (and religiously), you can guarantee a decent average return over the long term. It’s called dollar-cost averaging, if you’d like to learn more.
Step 6 – Use the power of compound interest
Einstein called compound interest the ‘eighth wonder of the world’ and for good reason. Getting the snowball rolling is vital to securing long-term wealth. So if you never sell your index funds and make sure any and all dividends get reinvested, you stand the best chance of benefiting from this benevolent force. As your reinvested dividends pay dividends, you will at last start to make money while you sleep.
There you have it – a fairly simple roadmap to getting wealthy and earning money while you sleep. It won’t make anyone rich overnight and all 6 steps are necessary for building wealth. But remember, as soon as you buy your first share, that’s when passive income starts. What are you waiting for?
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2019