Friday, May 9, 2014

And We're Off!! I've created this blog to track my progress towards my goal of owning a Tesla Model S. I'm doing things a bit differently than most people, however. Most people would save up enough for a down payment on the car or perhaps even the total cost of the car, then go out and buy it. Not me.

I've been investing in real estate for over a decade and one of the most important things I've learned from that is the power of passive income. For the purpose of this blog, I will define passive income as income you receive from invested money. It's money that your money earns, not you. The example most people are familiar with is interest earned from money in a bank account. Other examples are income from a rental property, interest payments made to you on a loan you made, and dividends from stocks. These are all instances where your money earns more money for you. You get that money whether or not you are working, on vacation, sleeping, or whatever. It's completely passive on your part.

There are many ways to get rich. One of those is to buy assets that generate passive income. If you do this long enough, you'll eventually accumulate enough assets so that the passive income they generate will exceed your living expenses. At that point, you no longer have to work for income, which is most people's definition of "rich."

The Tesla Model S is an expensive car. As of this writing, the version I want with the options I want lists for $96,770. That's a big chunk of change. If I had that money sitting in a bank account, I could buy the car. But everyone knows what happens to the value of a car over time - it drops. So by buying the car outright, I've traded a huge lump of cash, which I could use to generate income, for an asset that will go down in value as time goes on. Even if I took out a loan to purchase the car, I'm still spending money that I earned (non-passive income) on something that will decrease in value. This is Not Smart.

Instead, I want to use investment income to pay for the car. There is some amount of money that, when invested, will generate monthly income equal to or greater than the amount of an auto loan payment. All I need to do is collect my investment income each month, then send it in as my auto loan payment. No net money out of my pocket! As a bonus, I can make the car payments whether or not I have a job. But the best part of this is that after the car loan has been paid off, I'll have BOTH the car and the lump of money I have invested! Score!

The trick to performing this financial magic is finding an investment that provides you with a high enough consistent rate of return and that is also safe enough so that your principle is not lost. Let's look at a couple of options:

  • Savings Accounts: If you've checked your bank statement lately, you've probably noticed banks are paying virtually nothing in interest right now. Currently, a 5 year $100,000 certificate of deposit, typically the highest paying savings vehicle a bank or credit union offers, is only paying 1.2% interest. That means if you invest $100,000, you'll get paid $100 per month in interest. If you figure your car payment will be around $700 a month, you'll need to invest $700,000 to cover that payment. Clearly, this is not the way to go.

  • Dividends from stock: Many publicly traded companies pay dividends to their shareholders. Looking at the top dividend paying stocks in the Dow Jones Industrial Average (as of the day I'm writing this), AT&T is currently the highest paying one with a dividend yield of 5.15%. The dividend yield of a stock is defined as the yearly dividend amount paid per share divided by the price per share of the stock. For example, AT&T is currently paying a $1.84 dividend and the stock price is currently $35.76. So 1.84 / 35.76 = 0.51454, or 5.15%. But there are some problems with this. First of all, companies are under no obligation to pay out a dividend. They may decide to reduce their dividend or cancel it altogether. The dividend yield is also dependent on the company's share price. So if you bought some AT&T stock today at $35.76, your money would be earning 5.15% interest. But suppose 6 months from now, AT&T is trading at $42. Now, the dividend yield, assuming the actual dividend amount remains at $1.84, drops to 4.4%. And let's not forget you have to pay commissions whenever you buy or sell a stock. If you are trying to save money over an extended period and you make frequent purchases of stock, your commission costs will likely eat up any profits you might get from dividends. Furthermore, the changing stock price will make it very difficult to earn a consistent rate of return. So this isn't the best option either.

  • Real estate: This is, in my opinion, the way to go. Perhaps this isn't surprising since I've been investing in real estate for so long. In this case, I'm not talking about renting property, but rather hard money lending. I've done over 30 hard money loans and am still doing them. I receive a 9% return on my investment with these loans and they are secured by real estate (meaning I'm listed on the mortgage as a lender and I can foreclose on the property should the borrower not pay). I'm not going to go into all the details of hard money lending here (after all, I've been blogging about that for 10 years here), but suffice it to say that I believe this represents a safe, dependable, high value passive income stream.
So now that I've determined what type of investment I'm going to use, I need to figure out how much I need to invest. I'll go over how I did that in my next post. Warning: there will be math. But I'll also include some bunnies, so it won't be too scary.

1 comment:

  1. Great blog! Anyone new to your blogs will quickly realize that you absolutely know what you are talking about. I know you'll reach your goal!!

    On a related note, does the Tesla come with bunnies? Because I have an irrational fear of most fleet-footed animals that /appear/ docile. So, as your wife, if the Tesla comes with bunnies, that's a deal-breaker for me.