Passive income is overrated.
Everybody is talking about passive income, and it is quite silly of me to swim against the current. But I feel that this is a topic that deserves more attention from the other standpoint. To put it out there, I’m not against passive income. But rather, something bigger, and something more important. I found that many supporters of passive income are supporting it just because the idea of passive income sounds good. Yet, the idea that I want to challenge is not whether passive income is good or bad, but rather, “Is it suitable for me RIGHT NOW?” – I wonder how many actually thought about this?
I began my investing journey at 18 as an active trader. It was fun, exciting and rewarding at the same time. I was reading books about technical analysis, chart patterns, indicators and learning from the full-time traders who upload their videos online. It went on for about 2 years before I decided to try something different and turn from a trader into an investor. That’s also the time when passive income started getting popular and was quite the talk of the town. Convinced it was the way to go, I converted my portfolio into one that was yielding 8% dividend annually and did that for a year or so. But I decided to walk away from passive income for now. At this point, you might be thinking, 8% yield isn’t that bad at all! Considering inflation, and the effects of compounding, why would I want to give up a passive income of 8%?
Why Did I Give Up My 8% Yield?
In terms of yield, 8% is rather respectable, at least compared to whatever the banks and fixed deposits are offering. While the yield looks good, the nominal amount of dividends I actually received is rather bad. The truth is, as a young investor, the kind of “passive income” I was getting at the 8% was merely an average of $100 per month. Of course, this is money that I did not have to work for. But why did I choose to let it go? It didn’t occur to me that with a small capital base, any yield is basically pretty meaningless.
I was simply comfortable receiving my additional money not thinking about my opportunity costs. I was so focused on building that passive income just by re-investing my dividends that it never occurred to me that if I focused on building my capital base instead, I would reach my first dividend goal of $1000/month possibly much sooner. At 8% yield, this translates into needing $150k in capital. If I keep collecting $100/month, slowly but surely, I’ll get there. But a basic mental calculation would tell you that even after accounting for compounding effects, it’s going to take too long a time.(At $1.2k/year, even after 10 years, you’re nowhere near $150k. Maybe 10% of it.) And it just doesn’t seem like the plan that would help me achieve my goal!
Therefore, my focus now is on building my capital base through Value-Growth Investing, where I switch my focus from companies that pay generous dividends to companies that are in the phase of growth where companies use the money that could have been paid as dividends to fund their expansion plans instead. With a growing company, I expect its share price to grow as well, and definitely by more than 8% because that’s my opportunity cost, isn’t it? Is it guaranteed I’ll always find a company that will keep giving me >8% return per year? No, of course not. In at least the next 10 years, just for the sake of comparison with the above paragraph, can I possibly find and invest in a handful of companies that can give me supernormal returns? I certainly hope so, and I’ve already witnessed a number of them within the past 2 years, what more, 10 years. Therefore, I remain confident that this plan of focusing on capital gains will be more feasible to help me turn my goal into a reality.
I hope by now, you see where I am coming from, and possibly resonate with what I am saying. The faster I can build my capital, the greater the nominal amounts of dividends I will receive when I convert back into a dividend portfolio. Rather than look at the yield, I’m focusing on what truly matters – The Capital. I could boast all day about having a 10% or 12% dividend yield portfolio, but it’s meaningless if I only have $100 in capital. Do you see where I am coming from now?
So what’s the end game?
The end game is still back to a dividend portfolio. As I reach that age (Maybe 60 maybe 70 or 80?) I know my mind will not be as sharp, and things might have changed so much that I am not updated in my way of thinking anymore. The more I try to handpick companies, the more it could work against me. So I’ll let the passive income do the job when I’m older.
I know I did not include capital injection, which is an important element in any kind of investing, be it income investing or value-growth investing. Both forms of investing have its perks and its drawbacks. All I am saying is, don’t build a passive income for the sake of building it. Build it because it makes sense to you.