Most investors I’ve been talking to want to turn their net worth (or “nest egg”) into monthly checks that replace their active income (from a job or business) and cover their living expenses.
If you are an investor (and most people are forced to become passive investors at least in their retirement accounts), chances are you want a consistent and predictable cash flow or passive income stream that is at least 10% (annualized yield) of the lump sum you have to invest.
So if you have $1 million to invest, you may want to generate a 10% return or $100,000 cash flow per year.
The interest in safe and secure double-digit cash flow increases as people approach retirement. They don’t want to reduce their standard of living but they do want to reduce their active working hours, or have the option to take time off work to enjoy life.
Why is a simple, predictable return of 10% per year so difficult to achieve passively?
Here are some of my thoughts:
- While you could build a successful business that produces 10% or more annual cash flow, it would require your active engagement (at least initially) and therefore would not be a passive investment from the start.
- The business cycle is “lumpy” and therefore it is unrealistic to count on a consistent cash flow for a long period of time.
- The law of supply and demand in the free capital markets will cause an investment that yields double-digit returns consistently to be bid up so high that the yield will eventually fall below 10%.
I will expand upon these ideas in future posts.
Thus, the mythical 10% per year passive cash flow will remain just a dream for most passive investors.
What do you think? What kind of passive investments can you think of that produce 10% or more annualized cash flow consistently right from the start? Please add your comment and let me know.
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It is a little hard to quantify the tax impact as each individual investor has different tax situations. However, we do need to consider the impact of fees or compensation for management of the asset.
In this context, we should be talking about after-fee investment returns only.
Great point Alan about taxes. Investors would need mid-double digit returns just to get a 10% return after taxes.
Thanks for commenting too.
Don’t forget to factor in taxes. Depending on the type of cash produced, the tax rates can vary (e.g. dividend income versus personal income versus capital gains), which reduces your return. One might need 15% return to net 10%.
And if inflation is around the corner, than a static 10% return will get reduced as inflation rises. Although, inflation rate is such a generic number, I can’t easily calculate what inflation % is at the individual level like I can with taxes.