The Easiest Form of Passive Income

Disclaimer

Passive income is all about putting effort into setting up a system in the short term that will continue to produce income in the long term. Investing is, by far, the easiest passive income source to set up because you just have to buy and hold. The effort required is minimal but the ongoing rewards can be plentiful. There is a difference between passive and active investing. If you regularly spend time researching and purchasing individual stocks, I would count this as active investing. The rewards can be large if you pick the right investment but picking the right investment is no easy feat.

 
Easiest Form of Passive Income Pin
 

The "how much would I have now if I had invested in (company name) on (date)?" game is an interesting one to play. "What if I had invested in Apple stock (AAPL) in July 1997?" (the month Steve Jobs returned to the company). It's an interesting thought experiment but put yourself back into the context of 1997 and the success Apple is today, reflected in the share price, was difficult to predict. Success in active investing will require time, research, skill and likely chance. And success is in no way guaranteed. 

Passive investing, on the other hand, is about growing your capital with little requirement for time and skill. You will be looking for a system you can repeat and possibly automate, with no/low setup fees and low ongoing costs. 

my Current Investment Portfolio

The content below is for informational purposes only. You should do your own independent research and/or seek help from a professional before making any investment decisions. 

Index Funds

 

Vanguard Index Funds:

35% - US Equity

30% - FTSE Global All-Cap

30% - FTSE UK All-Share

5% - Emerging Markets

The Index Fund

I hold an all index fund investment portfolio in a Stocks and Shares ISA with Vanguard. Superficially speaking, this portfolio looks relatively simple. Each index fund tracks an index such as the FTSE All Share (comprised of the largest 2000 companies traded on the LSE by market cap size). In doing so, you can be exposed, easily and cheaply, to a range of sectors, countries, market-caps etc. To give you an example, the Vanguard Global All-Cap Index Fund physically acquires stocks in both developed and developing countries, in sectors ranging from finance and technology, to consumer goods and services. 

Just buying into one index fund grants you instant diversification. I hold a total of 4 funds (above) which track a range of indices, from the US Equity Index to the Emerging Markets Stock Index. The addition of an emerging markets index fund is designed to give me greater exposure to markets in developing countries, including the BRIC nations (Brazil, Russia, India and China).

Fees and Charges

When you buy a mutual fund or an index fund, there is an ongoing charge to pay (OFC) which covers employee salaries, bonuses, office space and so on. The huge benefit of the index fund is that its very nature makes it cheap to run. As it is only designed to track an index the fees are substantially lower than the industry average. It is true that the difference in fund charges between active and passively managed funds might be only half a percentage point. But over the long term, that difference can be substantial. 

"Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it" - Albert Einstein.

Let's take two funds, one with an ongoing charge of 0.5% and the other with an ongoing charge of 1%. You invest £10,000 in each. What are your funds worth 30 years later, assuming an average annual growth rate of 5% each? You don't add anything to them. The value of your 1% OFC portfolio will be £5,184 less than the your 0.5% OFC portfolio. Half a percent is the difference between owning  £32,014 and £37,198 in assets. 


Vanguard Logo

 

Vanguard Stocks & Shares ISA:

Annual Account Fee: 0.15%

Investment Range: Vanguard funds, ETFs

Transfer/Dealing/Exit Fees: None 

I am in no way endorsed by Vanguard. Instead, I'm just going to give them free advertising because of how much I love their company. I switched all of my investments to Vanguard index funds. Here are the major benefits:

Low Annual Account Fee:

0.15% on holdings up to £250,000, no charge on figures beyond that.

Low OFCs:

The annual OFCs start from as little as 0.06%.

No dealing charges: 

Vanguard arrange their own bulk trading times during the day, which allow for free trading. You also have the option of paying to trade at other times throughout the day. I would always use their free service. 

Their 40 years+ Experience in the Index Fund Industry:

The founder and retired CEO John Bogle created the first index fund in 1975. As of now 'The Vanguard Group' own global assets worth over £2.9 trillion.


My Goals and Setup:

investing through a Stocks and Shares ISA

I count investment income as a really easy form of passive income but I am a big believer in dividend reinvestment. The benefit of holding everything in a S&S ISA is that dividend income is not taxed and there is no capital gains tax to pay when assets are sold. Plus, when you buy shares, even in a stocks and shares ISA, you normally have to pay a 0.5% stamp duty on transactions over £1000. When it comes to buying funds, you do not have to pay stamp duty. And the same is now true with ETFs (exchange traded funds).

I compared the difference between an index fund and index ETF in another article. From April 2014, the UK government abolished stamp duty on the purchasing of overseas domiciled ETFs that are traded in London. London-traded ETFs from all the main providers are domiciled abroad. For example all Vanguard ETFs are domiciled in Ireland. 

Dividend Reinvestment

Below is my current investment setup. The funds are accumulating, meaning dividends are automatically reinvested. This helps automate the process and keep it passive. As of now, buying accumulating funds is the only way to automate the dividend reinvestment process with Vanguard. If you were to purchase Vanguard ETFs, there is currently no way to automate dividend reinvestments. You would have to manually reinvest the dividend income if that is what you are looking to do. 

As the Vanguard platform only recently came to the UK, I am expecting this to be updated in the relatively near future. My main aim is to maintain the balance of my portfolio. See my article on  rebalancing investments. I do this mostly by allocating my income to each fund in the appropriate percentage. If I need to rebalance my portfolio I can alter the allocations in order to achieve that. 

 
Investment Flowchart - Index Funds.png
 

My Monthly Passive Investor Report

I have been posting a series of passive investor reports since June 2018 where I look at the performance of my investments month-to-month. I go into each fund in more detail and I highlight a few events which occurred during the month. 

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