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 from this income stream 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.
Active Vs Passive Investing
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 most 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 strategy you can repeat and possibly automate, with no/low setup fees and low ongoing costs.
My Current Investment Portfolio
For an updated list of my investments, follow ‘my passive investments’ which I started back in June 2018.
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 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 (ongoing fund charges):
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 but I would always use their free service.
Their 40 years+ Experience in the Index Fund Industry:
The founder of Vanguard, 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).
If you want to invest above your ISA limit, you may have to open a general account and then transfer your investments into an ISA in a subsequent tax year.
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.
If you buy an ‘accumulating’ fund, dividends are automatically reinvested (see the benefits of dividend reinvestment) 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 Monthly Passive Investor Reports
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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Rich Dad, Poor Dad by Robert Kiyosaki
The Little Book of Common Sense Investing by John C Bogle
The Intelligent Investor by Benjamin Graham