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Creating a passive income is a great way to top up your earnings and allow yourself to do more of what you want with your time. The notion of a passive income is that after the initial setup, the income generator runs itself.
There is two stand out ways to obtain this that this article aims to cover: Investing in financial markets or buy to let property. We’re also going to cover how you can reduce workloads with whichever industry you decide to invest in, by adopting a letting agent, property manager or a wealth manager.
There are pros and cons to both types of investments, as well as a host of similarities. From the outset, if you’re not experienced in either, both can sound daunting. The sheer volume of jargon might be enough to scare off most. Index funds, passive funds, stamp duty, variable rates, letting agent fees, LTV and dividends are some to name a few.
Firstly, neither are ‘easy’. You’ll always need to do your research and understand what you’re getting into. You’ll need capital, a lump sum that you’re willing to put down to invest, which you will need to get to terms with that you might lose
Finally, while passive investment implies once its setup, you simply reap the rewards, this isn’t the case. You’ll need to periodically revisit your investment (whichever you make) to make key decisions, ensure it’s on the right track and tweak along the way.
As safe as houses
One option to creating a passive income is to invest in a buy to let.
The stumbling block with a buy to let is the infamous deposit. Usually, a buy to let mortgage requires a 25% deposit of the value of the property (i.e. 25% LTV). For a property in London worth £500,000, that’s a whopping £125,000. Then you’ll have stamp duty of £20,000 – £30,000 on top of that!
So comparing that to buying a fund which you can start with as little as £100, the barriers to entry are significantly higher for buy to let property.
But… sticking with the property above, you can expect a rent of around £1,800 a month. Taking out your mortgage, tax and other expenses, you could see £700-900 of profit per month.
Grow Grow Grow!
Also, you have property value growth to consider. If you buy the right property, it’s not uncommon to see growths of 70-100% over 10 years!
Usually, due to the nature of buying a property for buy to let purposes (the lengthy setup, the large deposit, getting in tenants etc), you’re invested in the property for the long haul, which means you’re likely to make a profit.
Looking at the cons of the property again, it can take months to find a property, get a mortgage and then wait for the previous owner to vacate, as opposed to setting up a fund which you can do in a matter of minutes.
Overall, in conjunction with the rent, you’re going to receive, a property investment looks like a good bet. There are obvious caveats, you need to make sure you’re not buying in an area in decline, or buying pre a large scale property dip. That being said, the property is always in demand and with a shortfall in the UK, any dips are likely to soon be overcome.
Run around collecting rent or get a property manager
But remember, we’re covering passive incomes. There’s not much passiveness in dealing with tenants, fixing property issues, collecting rent and so on.
These time burdening activities however can be overcome by getting services from a letting agent or a property manager. Services offered by these agencies seek to reduce landlord stress and the time needed to manage a buy to let.
Letting agent and property management fees, as well as services offered, differ per agency. Also, some have better reputations than others. This is why it’s vital to pick the right agent and do your background reading and research
Rent Round does the leg work for you. The site compares letting agents & property managers local to your property.
The search is free for landlords & it takes 30 seconds to get your results. You could end up saving £1,000’s on your rental expenses.
Financial Markets?
To make sure we’re on the same page, by investing in financial markets, we mean a combination of buying stocks/shares, bonds or funds (we’ll explain more soon). While investing in the buy to let market is simply buying a property to give to a tenant (or even a letting agent to manage).
Let’s get into it. Investing in the financial market can be rewarding. We’ve all seen the Wolf of Wall Street and Gordon Gekko reaping the rewards of financial markets.
If you’re lucky enough to understand financial documents and accounts or be savvy at predicting trends of markets, you may be able to choose a handful of companies yourself, buy them and hopefully watch them grow!
However, to the less experienced this can be difficult and very risky. Say for example a scandal hits the CEO of one of your chosen firms. The share price, therefore, drops significantly and you’re left with an underperforming investment. If you’d bought smaller chunks in hundreds of companies, this scandal would have affected you less.
Buying Funds
Spreading the risk is therefore recommended. One way to do this as alluded to above is buying smaller chunks in more companies. This can be done by putting money into a fund.
A fund is a collection of different products bought under one umbrella. For example, a tech equity fund will have shares of hundreds of technology companies across the globe. So let’s say you think that in 5 years, companies like Amazon, Facebook and Microsoft are going to be worth more than they are today, this type of fund may be for you. Instead of buying shares in each company individually, you can just buy allocations of the fund which have shares of each of those companies built-in.
Furthermore, if you’re not keen on one particular industry, you can invest in world trackers. These funds invest in the top few hundred companies around the world. So the same question applies, if you think the top companies will grow and be more valuable in a few years, this might be a solution for you.
Another benefit of buying a fund instead of the individual company shares is that with buying a fund, there is one trading cost (say £12). Whereas if you wanted to buy shares in 10 individual companies yourself, you may have more trading costs (i.e. £12 X 10). Trading costs depend on which trading platform you decide to go with.
Some funds aren’t just investments in companies, but provide a combination of other types of financial products, like government bonds, currency or even bitcoin!
Sign me up!
So there are so many options available. But how do you get involved? Again there hundreds of avenues, but we will talk about two that are the most popular.
Opening stocks and shares ISA is the first option. This is a wrapper where anything you make in this account is tax-free up to £20k a year. So you open up an account, transfer up to £20k and then buy your funds as described above.
You’ll need to be aware that for every trade you make, you could be charged a dealing fee and a yearly platform fee. To ensure you’re getting a good deal check out this analysis on stocks & shares ISAs from MoneySavingExpert.com.
It’s also important to distinguish between a stocks & shares ISA and a cash ISA. Cash ISAs involve no buying of funds, share, bonds etc. You simply put your money in and receive between 0.5-2.5% interests a year (it’s that simple). While the risks are low, so are the rewards.
Let someone else do it
If you’re interested in investing in the financial markets but not sure what companies or funds you would like to invest in, then a “do it for me” platform is the 2nd option. You set the level of risk you’re willing to accept and then the platform will do the rest for you. Providers like Nutmeg or Wealthify are examples of this service.
You may even find that these options prove cheaper than doing it yourself, usually because of the type of fund these companies use.
The rewards of investing in the financial markets differ, but there is money to be made. Take for example some of the large growths in share prices below. Investing in Amazon a few years back would have made a heavy profit.
Also, the same can be said if you invested in a US S&P 500 fund, even if you put in before the 2008 credit crunch crisis!
However, there are also bad investments to be made. Deutsche Bank’s share price has fallen from 59 EUR per share to 7.55 EUR over the last 9 years. Hence spreading the risk over many stocks or funds is a safer strategy.
After all that
Investing in financial markets & buy to let property can be very profitable. But as with all potential rewards, there are risks.
Both avenues of passive incomes have their advantages and the more research you can do, the better.
With the addition of rental profit alongside capital gains, it can be said that property can generate more income. But it’s the longer-term option due to setup costs & time. Also, the amount of capital you need to start investing is substantially larger, especially if your potential rental property is based in London.
Financial markets have little to no barriers to entry, it’s easy to set up and you don’t need massive amounts of capital to start. However the financial markets are turbulent, so you have to prepare to see your capital take a significant hit if the market doesn’t go your way. Funds and collective investments can help reduce your risk exposure.
If you’re in the advantageous position of doing both, that’s ideal. Investing in both popular investment vehicles will help spread risk.
The good thing about both options is the chance to get someone to do a proportion of the hard work for you. A wealth manager that picks financial instruments for you is growing in popularity.
If a buy to let investment is for you, then getting a good letting agent or property manager can reduce your effort requirements drastically. The agent will take on some of the most cumbersome landlord activities.
Use Rent Round to compare property manager fees and find the most competitive and highest performing agents.