It's All About Cash Flow

While saving and investing can allow you to build up a sizeable net worth, the reality is that in order to achieve true financial independence, you need to have money coming in that does not require your physical time and effort to generate it.

You’ve probably heard (more than once) the old expression “Make your money work for you.” Nowhere is this more evident than when your savings generate “residual” or “passive” cash flow. The good news is that there are a variety of ways to generate passive income and cash flow.

Understanding Passive Cash Flow and How It Works

As its name implies, passive income is essentially the opposite of active income. Earning passive income means you don’t have to spend endless hours in traffic commuting to a drab office cubicle, and you won’t be required to work the “occasional” evening or weekend.

Instead, passive income is earned by strategically placing your money into financial vehicles that will produce income for you, regardless of how you spend your day. (And yes, it can even be earned while you are sleeping.)

If this sounds too good to be true, remember there are likely many examples of passive income-generating methods that you are already familiar with, but just didn’t realize that these techniques were actually making money for someone.

There are a number of ways to generate passive cash flow, including:

• Dividends from Investments. Dividends can be received from certain types of stock investments. In many cases, dividend payments are a certain amount of income per share, multiplied by the number of shares you own. While dividends are never guaranteed, this type of passive income can be received for as long as you own the stock (unless there is a change in the company’s dividend-paying option).

• Interest-Bearing Accounts. Income from investments may also be received via regular interest payments. This can be as simple as opening up a savings account and receiving the interest additions to your account through regular payments from your bank or other financial institution. While savings and moneymarket accounts typically pay a very low rate of interest, this can still be a viable method of earning some passive income while keeping your principal stable. Similar options include interest that is earned from bonds or CDs (certificates of deposit).

• Annuities. An annuity can provide you with an income that you literally cannot outlive. These financial vehicles are designed to provide cash flow in return for either a lump sum or periodic contributions. Annuities also come with advantages such as tax-deferred growth and asset protection in some states, including Texas.

• Real-estate Investments. Owning investment real estate is one of the oldest and most common ways of generating passive income. Everyone needs a place to live, so your “product” will likely always be in demand. The most common form of income-generating real estate is rental income. This can entail purchasing a single-family home and renting it out, obtaining a duplex or 4-plex and leasing to tenants, or acquiring a large apartment building and receiving rent checks from numerous tenants every month. Passive income can be obtained via commercial properties as well. With real estate, it is easy to start small and then expand to multiple properties, each bringing in their own stream of regular income. Plus, if you don’t want to actively manage the property and the tenants, a property-management company can take on those duties for you.

• Interest on Loaned Money. If you have loaned money to someone such as a friend or family member, you could receive regular income as your borrower makes their repayments with interest. Of course this is a riskier strategy, as any time you lend money there is always risk of default. With that in mind, it is important to ensure that you implement all of the necessary paperwork, such as a promissory note that may include a collateral agreement.

How to Become Financially Independent

Because everyone’s goals, time frame, and risk tolerance are not the same, different incomeproducing strategies are needed for different investors. Before you move forward with committing to income investments, it is important to discuss your objectives with an experienced financial professional. That way, you can better ensure that you’re moving in the right direction and can take action on any changes that may be necessary going forward.

Grace S. Yung, CFP , is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial Group LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the September 2017 issue of Texas Monthly. Yung can be reached at grace.yung@lpl.com.

By GRACE S. YUNG, CFP