Author Topic: Reinvesting passive income question  (Read 8124 times)

refaelsh

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Reinvesting passive income question
« on: September 12, 2012, 07:48:16 AM »
Hello everyone,
MMM is always talking about the 7% rate on investment in Vanguard Index.
I am from Israel, We don't have such a thing. What We do have is called "trust fund" (approximate translation).
Here is a wikipedia article explaingig what is it: http://en.wikipedia.org/wiki/Collective_investment_scheme.
The thing is, it only makes approximately 5%, and that is before inflation.
But that is not My problem.
My problem is I cant understand what MMM means when He is talking about:
1. Living on passive income from that 7% (or 5% (before inflation) in My case)*.
2. Reinvesting the passive income (or part of it) to make more passive income.

Now, let Me explain. This "trust fund" is very similar to stock in that way that You buy "units" of this "trust fund"
and then, after a year the price have gone up 5% (before inflation).
Lets say I bought 100 units for 1$ each.
After a year, those 100 units now cost 105$, e.g., each unit now costs 1.05$ (105$ divided by 100 units).
You see, what I don't understand is:
3. How do I get those extra five dollars I just earned?
4. How do I reinvest those 5 dollars?

The only possible thing to do (as I see it, therefor I need Your help) is to sell 4 units for 1.05$ dollars each and get 4.2$.
But:
5. Now I have only 96 units (that were originally bought at 1$ each). Now each unit costs 1.05$ which means in total 100.8$ (96 units multiplied by 1.05$). Next year it will grow by 5% (before inflation), e.g., 105.84$ --> More then the year I had before (last year it was 105$), this good.
6. But now I only have 96 units left. This is bad. I Will run out of units at some point. I guess I can buy the 4 units back for it to be 100 again, but:
6.1 Now the price is 1.05$ --> So it is bad to reinvest again because I now 4 units of those 100 units cost Me more (1.05$ dollars and not 1$).
6.2 Or I should not sold them in the first place, but then, where is My passive income?

Thanks in advance. Refael Sheinker from Israel.

P.S. The 5% percent before inflation is also before tax of 20%.
P.P.S I talk in dollars to make it easier because most of the readers are from USA.
P.P.P.S If I get lucky, MMM himself might just answer My question.
P.P.P.P.S This is My first post ever! How was I?

*Wow, double parenthesis.**
**Wow, I now use the asterisk thingy just like MMM, I need a therapist... I think...

Richard3

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Re: Reinvesting passive income question
« Reply #1 on: September 12, 2012, 08:00:50 AM »
If the price has gone up to 1.05, then by not selling you effectively have reinvested the income. In this case you would just sell however many units you needed to generate the income you wanted.

So you have 100 $1 units.
Price goes up and you have 100 $1.05 units.

To cover $3 of spending you sell 3 units.

You now have 97 $1.05 units (worth 101.85), spent $3 and have $0.15 leftover.

If your units go up 5% again you have 97 1.105 units worth $107.185 and can again sell 3 to cover your expenses.

The price of the units doesn't matter as much as how much your total holdings are worth. As long as you have more $ worth of units than last year you are winning (or rather you need it to increase at least at the rate of inflation).

AJ

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Re: Reinvesting passive income question
« Reply #2 on: September 12, 2012, 08:09:05 AM »
If this is your only investment option, and the price of shares never splits, and you are not allowed to buy partial shares, then yes you would eventually run out of money. If all those things are true, you should definitely invest somewhere else. This would be like if our only investment option was Berkshire Hathaway here in the states. Yes, it might give a good return, but it is not practical for withdrawing. You should research whether you can buy partial shares and whether the price ever splits.

refaelsh

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Re: Reinvesting passive income question
« Reply #3 on: September 12, 2012, 08:28:51 AM »
Wow!!!
A replay in less then 5 minutes. I've never seen a forum so active like this.
Thank You very much Richard3.
If your units go up 5% again you have 97 1.105 units worth $107.185 and can again sell 3 to cover your expenses.
How did You calculate it? I get different numbers: 97 units 1.1025 worth 106.9425. Where is My mistake?
The price of the units doesn't matter as much as how much your total holdings are worth. As long as you have more $ worth of units than last year you are winning (or rather you need it to increase at least at the rate of inflation).
Ye, You are right. But eventually I will run out of units and My passive income would be gone. As far as I understand, MMM's passive income source never runs dry as mine, am I right?

sol

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Re: Reinvesting passive income question
« Reply #4 on: September 12, 2012, 08:39:22 AM »
US stock indices return two different kinds of income.  The first is capital appreciation, which is just the new higher market price for the shares that you've bought.  The second is dividend income, which is a direct cash payment that some companies make to shareholders out of corporate profits.

Dividends can either be taken as a direct payment to you, in which case they show up in your bank account, or they can be reinvested to buy additional shares.  Most people who are still accumulating assets choose the latter.

Over the long term, dividends have provided a significant part of total stock market returns. 

pepper

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Re: Reinvesting passive income question
« Reply #5 on: September 12, 2012, 10:49:43 AM »
I am not familiar with the Isreali market, so my apologies if this doesn't apply to you, but it looks like the TASE (Tel Aviv Stock Exchange) has a many investing options including ETFs (exchange traded funds) that would be similar to what Vanguard provides in the US. 

I am not sure if you have already looked into this but according to wikipedia:

"TASE lists some 622 companies, about 60 of which are also listed on stock exchanges in other countries. TASE also lists some 180 exchange-traded funds (ETFs), 60 government bonds, 500 corporate bonds, and more than 1000 mutual funds."

Richard3

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Re: Reinvesting passive income question
« Reply #6 on: September 12, 2012, 11:29:59 AM »
I
Wow!!!
A replay in less then 5 minutes. I've never seen a forum so active like this.
Thank You very much Richard3.

If your units go up 5% again you have 97 1.105 units worth $107.185 and can again sell 3 to cover your expenses.
How did You calculate it? I get different numbers: 97 units 1.1025 worth 106.9425. Where is My mistake?

My mental arithmetic is terrible. Sorry for any confusion. 1.05 * 1.05 does in fact equal 1.1025.

The price of the units doesn't matter as much as how much your total holdings are worth. As long as you have more $ worth of units than last year you are winning (or rather you need it to increase at least at the rate of inflation).
Ye, You are right. But eventually I will run out of units and My passive income would be gone. As far as I understand, MMM's passive income source never runs dry as mine, am I right?

Remember the leftover we had each year? You would be buying more units with that (or rather selling 2.7 units or whatever if that was possible).

The other thing to remember is that as the $ value of the units rise you would sell less of them. Once a unit hits $1.50 (~8 years I think) you're only selling 2 per year to cover your $3 expenses.

If your passive income source runs dry it's because you're spending more than the capital gain each year, not for any other reason.

refaelsh

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Re: Reinvesting passive income question
« Reply #7 on: September 13, 2012, 02:22:43 AM »
If this is your only investment option, and the price of shares never splits, and you are not allowed to buy partial shares, then yes you would eventually run out of money. If all those things are true, you should definitely invest somewhere else. This would be like if our only investment option was Berkshire Hathaway here in the states. Yes, it might give a good return, but it is not practical for withdrawing. You should research whether you can buy partial shares and whether the price ever splits.
Thank You for Your answer.
But this is not a stock, therefor it will never split.
Do You have any ideas of investment that are practical for withdrawing?

refaelsh

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Re: Reinvesting passive income question
« Reply #8 on: September 13, 2012, 02:24:22 AM »
US stock indices return two different kinds of income.  The first is capital appreciation, which is just the new higher market price for the shares that you've bought.  The second is dividend income, which is a direct cash payment that some companies make to shareholders out of corporate profits.

Dividends can either be taken as a direct payment to you, in which case they show up in your bank account, or they can be reinvested to buy additional shares.  Most people who are still accumulating assets choose the latter.

Over the long term, dividends have provided a significant part of total stock market returns.
Thank You for Your prompt answer.
But this is not a stock per say. It is more of a "mutual bonds fond". It does not hands out dividends.

refaelsh

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Re: Reinvesting passive income question
« Reply #9 on: September 13, 2012, 02:33:00 AM »
I am not familiar with the Isreali market, so my apologies if this doesn't apply to you, but it looks like the TASE (Tel Aviv Stock Exchange) has a many investing options including ETFs (exchange traded funds) that would be similar to what Vanguard provides in the US. 

I am not sure if you have already looked into this but according to wikipedia:

"TASE lists some 622 companies, about 60 of which are also listed on stock exchanges in other countries. TASE also lists some 180 exchange-traded funds (ETFs), 60 government bonds, 500 corporate bonds, and more than 1000 mutual funds."
Thank You very much!
But unfortunately, the wikipedia article about EFTs does not has a Hebrew version and I don't know how to translate EFT to Hebrew in order to research the local terms and lows and regulations about EFTs.

refaelsh

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Re: Reinvesting passive income question
« Reply #10 on: September 13, 2012, 03:04:10 AM »
If your passive income source runs dry it's because you're spending more than the capital gain each year, not for any other reason.
Thank You for Your informative replay.
But may I have Your permission to disagree with You.
My passive income source will run dry not because I will be spending too much but because I will be selling X amount of units every year and those units will run dry.
This is because this particular option of "mutual bonds fund" is not withdrawn friendly.
I am looking for a way to make it withdrawing friendly.
Or find another investment option which is withdrawing friendly.

Richard3

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Re: Reinvesting passive income question
« Reply #11 on: September 13, 2012, 05:23:00 AM »
You can disagree with me, but you will be wrong. :)

If the total value of your investments grows faster than you are spending it, it is mathematically impossible for you to run out of money. Now maybe transaction costs for selling or granularity (only having 100 units and not being able to divide them) make this impractical as a source of income, but in a vacuum the units will not run dry.

By some crude excel work your investment would last 70 years before you hit 0 units and you would then have 405 in cash accumulated from the excess of what you sold over what you spent.  This is 135 years of spending assuming you must sell 1 unit a year minimum and can't ever buy more. If you had sold one less unit whenever you had the cash to avoid selling the investment would last much longer.

refaelsh

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Re: Reinvesting passive income question
« Reply #12 on: September 13, 2012, 05:42:17 AM »
You can disagree with me, but you will be wrong. :)

Now maybe transaction costs for selling or granularity
There are no transaction costs what so ever. There is only negligible constant payment per month of 15 NIS (approximately 4$).
The granularity is also not a problem. I cant off course sell/buy fractional amount of units, but the 100 units is only an example. I currently have approximately 15000 units.

You can disagree with me, but you will be wrong. :)

but in a vacuum the units will not run dry.

Can You please explain again what You meant bu saying: "but in a vacuum the units will not run dry."?

Richard3

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Re: Reinvesting passive income question
« Reply #13 on: September 13, 2012, 06:44:03 AM »
Basically I mean that in the arbitrary "world" we have created you will not run out of units. It's not a very realistic simulation because returns, inflation, and expenses are all completely fixed.

The "vacuum" expression is from high school physics, where my teacher would make the problems easier by setting them in a vacuum so we could ignore friction / air resistance etc and learn the theoretical formulas. "Run dry" is just another way of saying "run out".

I apologise for my lazy choice of words - I've attached the  excel (although it's also lazy - are you seeing a theme yet?).

refaelsh

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Re: Reinvesting passive income question
« Reply #14 on: September 13, 2012, 06:52:09 AM »
7
Basically I mean that in the arbitrary "world" we have created you will not run out of units. It's not a very realistic simulation because returns, inflation, and expenses are all completely fixed.

The "vacuum" expression is from high school physics, where my teacher would make the problems easier by setting them in a vacuum so we could ignore friction / air resistance etc and learn the theoretical formulas. "Run dry" is just another way of saying "run out".

I apologise for my lazy choice of words - I've attached the  excel (although it's also lazy - are you seeing a theme yet?).
I off course looked at the Excel (which by the way a very great Excel, I will definitely improve on it and re-post it here).
I still don't under stand why I will not tun out of units. My Logic clearly states that at some point in time I will tun out of units (Your Excel says it will happen after 70 years).

arebelspy

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Re: Reinvesting passive income question
« Reply #15 on: September 13, 2012, 07:39:29 AM »
You will not run out, in essence, because it growing faster than you spending means at some point your withdrawals will decrease such that the one unit you sell may cover a year and 1/2 expenses.  And then by the time you have to sell the next one, it may cover two years expenses, etc.

And if it does continue growing faster than your spending at some point you'll sell a unit that could cover 10 years expenses, etc.  Especially in a time-constricted environment (your life).
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
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pepper

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Re: Reinvesting passive income question
« Reply #16 on: September 13, 2012, 10:39:11 AM »
Thank You very much!
But unfortunately, the wikipedia article about EFTs does not has a Hebrew version and I don't know how to translate EFT to Hebrew in order to research the local terms and lows and regulations about EFTs.

According to this article http://www.tase.co.il/TASEEng/NewsandEvents/PRArchive/2009/PR_20090811.htm, the financial equivalent of an ETF on the TASE is called "Kranot Sal" in hebrew.  Here is the relevant quote from the article:

"As the Hebrew name suggests, “Kranot Sal” (literally “basket funds”) constitute a hybrid between open-end mutual funds and exchange-traded notes (ETNs) referred to in Israel as "Teudot sal" (literally “basket certificates”). This new instrument is based on the American model of Exchange-traded Funds (ETFs), but has been adapted to Israel’s capital market by incorporating elements drawn from the local ETN market. The Kranot Sal ETFs will be structured as tracker funds, i.e. a fund whose express policy to track through replication a market index or other underlying asset. Unlike existing mutual funds, the new instrument will be traded on the Tel Aviv Stock Exchange and the process of creating and redeeming fund units will be incorporated in the trading process."

Richard3

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Re: Reinvesting passive income question
« Reply #17 on: September 13, 2012, 12:12:22 PM »
I've done a new excel to take in to account spending last year's leftover cash.

You sell a unit in year 114, leaving you with 34 units for year 115. Since the unit was worth $236, you don't have to sell another unit for another 78 years.

In fact, you still have 33 units and $6600 in cash left in year 1696 (just where I stopped pasting to) which to my mind is proof enough it is sustainable.

For the record it will be another 2 and a bit millenniums before you need to sell another unit and even if the price stops growing in 1696 you will earn 784,643,939,174,674,000,000,000,000,000,000,000.00 from your next sale which is quite a lot of money.

arebelspy

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Re: Reinvesting passive income question
« Reply #18 on: September 13, 2012, 12:17:08 PM »
Yes, that is what Iwas trying to get at.  As long as the earnings outpace your spending (inflation adjusted, naturally), you shouldn't run out.
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refaelsh

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Re: Reinvesting passive income question
« Reply #19 on: September 15, 2012, 01:33:47 PM »
You will not run out, in essence, because it growing faster than you spending means at some point your withdrawals will decrease such that the one unit you sell may cover a year and 1/2 expenses.  And then by the time you have to sell the next one, it may cover two years expenses, etc.

And if it does continue growing faster than your spending at some point you'll sell a unit that could cover 10 years expenses, etc.  Especially in a time-constricted environment (your life).
Oh, I see Your point and I like it :-)
But still, it would be better and more convenient if there was some investment that would generate a passive income but will be withdrawing friendly and without the "units running out" thingy.

refaelsh

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Re: Reinvesting passive income question
« Reply #20 on: September 15, 2012, 01:35:40 PM »
Thank You very much!
But unfortunately, the wikipedia article about EFTs does not has a Hebrew version and I don't know how to translate EFT to Hebrew in order to research the local terms and lows and regulations about EFTs.

According to this article http://www.tase.co.il/TASEEng/NewsandEvents/PRArchive/2009/PR_20090811.htm, the financial equivalent of an ETF on the TASE is called "Kranot Sal" in hebrew.  Here is the relevant quote from the article:

"As the Hebrew name suggests, “Kranot Sal” (literally “basket funds”) constitute a hybrid between open-end mutual funds and exchange-traded notes (ETNs) referred to in Israel as "Teudot sal" (literally “basket certificates”). This new instrument is based on the American model of Exchange-traded Funds (ETFs), but has been adapted to Israel’s capital market by incorporating elements drawn from the local ETN market. The Kranot Sal ETFs will be structured as tracker funds, i.e. a fund whose express policy to track through replication a market index or other underlying asset. Unlike existing mutual funds, the new instrument will be traded on the Tel Aviv Stock Exchange and the process of creating and redeeming fund units will be incorporated in the trading process."
Cool!!! Thanks a lot pepper!!!

refaelsh

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Re: Reinvesting passive income question
« Reply #21 on: September 15, 2012, 01:41:16 PM »
I've done a new excel to take in to account spending last year's leftover cash.

You sell a unit in year 114, leaving you with 34 units for year 115. Since the unit was worth $236, you don't have to sell another unit for another 78 years.

In fact, you still have 33 units and $6600 in cash left in year 1696 (just where I stopped pasting to) which to my mind is proof enough it is sustainable.

For the record it will be another 2 and a bit millenniums before you need to sell another unit and even if the price stops growing in 1696 you will earn 784,643,939,174,674,000,000,000,000,000,000,000.00 from your next sale which is quite a lot of money.
Thank You very much for being patient with Me :-)
I now get it, the units may eventually run out at some point in time, but I will be long dead by then :-)
I just have to take of granularity - this is easy because:
1. This was a hypothetical example, I will have much more then 100 units (I currently have around 15k units and each is prices around 1.2 NIS (approximately 0.3$).
2. I will by a different type of units - ones that still produce the mentioned 5% but costs less per unit as possible.

Thank You again.

P.S.
This is Excel is even better the the previous one. Kudos!!!

refaelsh

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Re: Reinvesting passive income question
« Reply #22 on: September 19, 2012, 03:50:29 AM »
And to sum it up:
After some more research I now know that buying stock of companies that pay dividends regularly is a much
more withdrawing friendly way of investing then buying "trusts funds" or similar.

Can You please suggests more ways of investment that are more withdrawing friendly?

arebelspy

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Re: Reinvesting passive income question
« Reply #23 on: September 19, 2012, 06:45:42 AM »
I'm a total return over dividend guy myself.  I'm okay selling some, and would rather than than dividends, in general.

Even more than that, I'm a rental returns guy (as of right now, and for the foreseeable future, at least).

There are lots of strategies one might favor.  I'd start with some basic reading over at the Bogleheads' wiki if I were you.  That'll just tell you the best ones.  ;)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
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refaelsh

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Re: Reinvesting passive income question
« Reply #24 on: September 19, 2012, 07:08:04 AM »
Thank You for Your answer.
I'm a total return over dividend guy myself.  I'm okay selling some, and would rather than than dividends, in general.

Can You please rephrase that sentence, I am having troubles with My English :-)

Even more than that, I'm a rental returns guy (as of right now, and for the foreseeable future, at least).

Out of curiosity; why rental? It still requires some work! Would You not prefer to sit at home and do nothing? Or play Civilization 5?

There are lots of strategies one might favor.  I'd start with some basic reading over at the Bogleheads' wiki if I were you.  That'll just tell you the best ones.  ;)

Can You please provide Me with a link?

arebelspy

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Re: Reinvesting passive income question
« Reply #25 on: September 19, 2012, 07:12:13 AM »
First part: I'd rather target more money overall, and be okay selling some, than target dividends.
Second: It doesn't take as much work as you'd think, but also I'm okay with what it does take for the phenomenal returns.  If you could offer me something as stable but more passive that would make me as wealthy, I'd do that.  I don't think anything else offers the opportunities real estate does right now.  This, of course, depends on your location (and many other factors).
As to the third: www.bogleheads.org/wiki/Main_Page
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.