What’s Passive Income? Learn the Basics

Passive income is a powerful tool for achieving financial independence and creating multiple streams of income. In this article, we’ll explore what passive income is, some familiar sources of passive income, and strategies for generating it.

What is Passive Income?

Passive income is income earned without having to work for it actively. This can include rental income from investment properties, stock dividends, royalties from creative works, and more. The beauty of passive income is that it allows you to make money while you sleep, freeing up your time to pursue other interests or spend time with loved ones.

Sources of Passive Income

To generate passive income, you can use a few key strategies. The first is to build a rental property portfolio. This involves purchasing and managing rental properties with the goal of generating regular rental income. To be successful in this strategy, it’s essential to research the local rental market, select properties with good potential for appreciation, and carefully screen tenants to minimize the risk of non-payment.

Another strategy for generating passive income is to invest in dividend-paying stocks. This involves purchasing shares of companies that regularly pay dividends to their shareholders. To be successful in this strategy, it’s essential to research the company’s financials, dividend history, and future growth potential.

If you have a creative streak, you can also generate passive income by monetizing your creative works. This could include writing books or articles, creating online courses, or producing music or art. To be successful in this strategy, it’s important to create high-quality content that resonates with your target audience and to market your work effectively.

Strategies for Generating Passive Income

To get started with generating passive income, here are some actionable steps you can take:

  1. Research potential passive income sources: Look into rental properties in your area, dividend-paying stocks, and creative work opportunities to identify potential sources of passive income.
  2. Develop a strategy: Decide which passive income source(s) you want to pursue and develop a plan for how to achieve your goals.
  3. Take action: Start investing in rental properties or dividend-paying stocks, or create and market your creative works.

Passive income can be a powerful tool for achieving financial independence and creating multiple streams of income. You can start earning money by carefully selecting passive income sources and developing a strategy for generating income. At the same time, you sleep and take control of your financial future.

The content on this site, provided by Able Wealth Management, is purely informational. While we aim for accuracy and completeness, we cannot guarantee the exactness of the information presented. The views and analyses expressed in this blog represent those of the authors at Able Wealth Management. They should not be considered as investment advice or endorsement of any particular financial instrument or strategy. Any references to specific securities and their performance are purely informational and should not be taken as advice to buy or sell.Before implementing any information or ideas presented, we strongly advise consulting with a financial advisor, accountant, or legal counsel. Investing carries inherent risks, including potential capital loss. Asset values can fluctuate over time and may be worth more or less than the original investment. Past performance does not guarantee future results, and Able Wealth Management cannot ensure that your financial goals will be achieved. Information from third-party sources has not been independently verified by Able Wealth Management. Although we trust these sources, we cannot assure their accuracy or completeness.

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Volatility Drag

Volatility drag, often unnoticed by many investors, plays a significant role in the performance of investment portfolios, especially in markets characterized by high volatility. Understanding volatility drag is crucial for making informed investment decisions and managing long-term investment performance.

Understanding Volatility Drag

Volatility drag refers to the negative effect of investment volatility on compound returns over time. It occurs because losses have a more significant impact on portfolio value than gains of the same magnitude. For example, if an investment loses 10% one year and gains 10% the next, the investment will not return to its starting value due to the mathematical asymmetry between gains and losses. This phenomenon underscores the importance of minimizing large fluctuations in investment value to protect long-term returns.

The Mathematics Behind Volatility Drag

The mathematical principle underlying volatility drag is relatively straightforward but profound in its implications for investors. The key concept is that percentage gains and losses are not symmetrical. A 50% loss requires a 100% gain to break even, not a 50% gain. This asymmetry means that volatility (up and down movements in price) can erode the compound growth rate of an investment, even if the arithmetic mean of the returns seems healthy.

Example of Volatility Drag

Consider an investment with the following annual returns: +20%, -15%, +10%, and -5%. While the arithmetic mean of these returns might suggest a modest positive performance, the compound annual growth rate (CAGR) would tell a different story, factoring in the volatility drag and showing a lower effective return than the arithmetic mean would suggest.

Implications for Investors

  • Risk Management: Understanding volatility drag emphasizes the importance of risk management strategies, such as diversification and the use of derivatives for hedging, to minimize significant downturns in portfolio value.
  • Investment Strategy: Investors might consider investment strategies that aim for steady, consistent returns over those with potentially higher but more volatile returns. Such strategies might include investing in low-volatility stocks, index funds, or using dollar-cost averaging to mitigate the impact of market fluctuations.
  • Psychological Aspects: Volatility drag also highlights the psychological challenge for investors who may overreact to short-term market movements. A long-term perspective is crucial for successful investing, as frequent trading in response to volatility can exacerbate the drag on returns.
  • Performance Evaluation: When assessing investment performance, considering both the arithmetic mean return and the compound annual growth rate (CAGR) can provide a more comprehensive view of an investment’s performance, factoring in the effect of volatility.

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