By following these four simple steps, over time you can make enough money through passive income to reach financial independence and never have to work again. This is the basic tenant of the FIRE movement
1. Boost your income
Develop a side hustle (or two!), negotiate that overdue pay-rise or pick up some extra shifts. Check out our guide on how to make more money.
2. Live well below your means
Develop a budget and stick to it! Use your savings to create an emergency fund, pay down any bad debt, and then build investment capital. Check our our free guide on how to budget and save money.
3. Invest your capital in low cost index funds
Create an online brokerage account and use it to buy good quality index funds such as ETFs and LICs with ultra low management fee’s. There are also many different index funds you can invest in. Check out our guide on index funds; LICs and ETFs to get the basics and work out which particular LIC or ETF index fund is right for you.
Whilst some people fancy themselves as stock pickers, the fact of the matter is that only an extremely small number of people are able to consistently outperform the market by picking stocks and actively trading. The most famous of these statistical anomalies is the Oracle of Omaha, Mr Warren Buffet himself. And what is his advise? Buy a low cost index fund and hold it!
Most investors fear a market downturn right after they make their investments, which is especially played on by the media. Remember that the majority of returns actually come from the dividends the share produces, not the capital growth in the share price itself. Most companies continue to pay dividends like clockwork regardless of the share price, which is passed right on to you the investor, through your index fund.
Crunch the numbers yourself, and you will see having significant idle capital is a defensive play which doesn’t pay off in the long run. Its best to put this money to work as soon as possible, and continue to top up your investments as much as you can. Its a great idea to keep a decent cash buffer, and this reserve means if the share price does go down that you can buy a heap more shares at a discount.
4. Manage your portfolio.
A very effective passive income investment strategy is to simply buy and hold the index, through index funds such as ETFs and LICs. Why would you want to kill the goose that lays golden eggs? Selling your index funds means your up for a second round of brokerage fees, as well as capital gains tax for any growth there has been in the share price.
By establishing a regular investment plan and buying more shares on a regular basis, you can even out the fluctuations in the share price – over time, you statistically will have bought more shares when the price is lower than you do when its higher, so your average price is reduced. This is called dollar-cost-averaging and is very popular in the FIRE community. Remember long term wealth is about time in the market, not timing the market, so continue to buy shares and hold them for the long term.
You can also register for a Dividend share Substitution Plan DSSP, or Dividend Reinvestment Plan DRP, where you receive extra shares in your fund rather than having that juicy dividend hit your bank account. There are advantages to both policies, and you usually receive the additional shares at a discounted rate to the market price and with no brokerage fees. You need to do your own research and get specialist advice as to which is best suited to you. By reinvesting the dividends your shares produce, you can grow your portfolio even faster.
Get rich slowly
Over time, the effect of compounding returns will grow your wealth. Whilst the share price may (and usually will) grow, the dividends produced is what you really care about. Reinvested, this lets your portfolio grow and eventually will become a valuable source of passive income, eventually providing more than enough for you to live on.
If you are able to save $1000 a month when you first enter the workforce at 18 years old, and invest this into good quality low cost index funds, assuming the market continues to perform on average (as it has over the past 200 years), by age 42 you would have made yourself over a cool one million dollars.
So – fancy being able to retire at 42 , having only ever invested $250 a week? This is the equivalent cost of a few luxury items such as a new car on finance or brand name clothing. For most of the work force, $250 doesn’t even represent a full days wage. A million dollars at a safe withdrawal rate of 4% means you can live of a passive income of $40,000 for the rest of your life!
If you are able to invest more (by boosting your income or living more frugally) and invest $2000 a month, you can shave off almost seven years off the process, and achieve this at age 35. Want to invest more? $3000 a month will get you it by 32, and $5000 a month gets you your million within 10 years. Whilst more aggressive investment brings your wealth quicker, the reduced time period means compound interest has less time to work its magic and it is doing less of your heavy lifting for you (in the last case, compound returns makes up just over a third of the total portfolio).
So there you have it – a pretty straightforward guide to how to get rich slowly using shares