Creating a Second Income Stream - Income Diversification

[actonyourown]

I posted this in my journal, but I thought this would be a good place to place it as well.

My current savings and investment rate (counting employer match and contributions) is around 37% of my gross pay and 51% of my net pay.  This leaves me with a possibly small portion of money each month that I currently just put into my savings account as extra savings ($50-$150/month).  This pandemic caused me to look at how precarious my income situation actually was and so after adjusting all of my payments to be automated and contributions going all to my Roth 401k and Roth IRA (not maxed yet, contributing $350/month now) I am looking to diversify my income sources.  My current employment is with a large bank in the S&P 500 and is very stable, however, it is not very high paying and I am obtaining my MBA (paid for by the company for 95% of expenses and cannot leave within 1 year of them paying or else I have to pay them back in full which I cannot do) so I would like to get into dividend investing as a passive income stream.  My issue is that many index dividend ETF’s are paying low rates but the high dividend rate funds scare me as well since they could be volatile or unsustainable. 

Since this is a diversification of income and non-retirement related investing, does it make sense to pursue yield (north of 5%) instead of using, say VYM (3.53%)?  Or should I look to buy individual stocks where yields can be 6-7% for some very strong companies?  I would consider preferred share ETFs as well and build asset diversification into this account.  I currently have TD Ameritrade and will pay $0 for ETF’s or stocks for the most part and I account for liquidity risk of these investments as well.  I’m worried that index REIT’s may not do well between possible upcoming evictions and corporations not renewing their leases in the future, but I would consider a small portion of VNQ in this case as well, just not my sole holding.

[robartsd]

I see little difference between investing for diversified income and investing for retirement. Either is for generating income in case your earned income falls short of your needs. The only difference I see is that retirement is a choice based on expecting investment income to meet all future needs and your diversified income would be used if your earned income falls short for other reasons. This sounds like an emergency fund to me. Personally I'd just increase savings in retirement funds until using all the tax advantaged space. If funds are really needed, Roth IRA contributions can be withdrawn penalty free at any time.

[yachi]

I forgot what subforum I was looking at and was expecting to read about a side gig.  I don't see a huge difference between dividend paying stocks and non-dividend paying stocks.  You can find crappy examples in both camps.

If you are going to buy dividend paying stocks, it makes more sense to do that inside a retirement account where you won't have to pay tax on the dividends. 

[bbqbonelesswing]

Over the long term, you are going to take a hit from taxes. It's up to you whether that's worth it for the added cash flow or not. I would suggest a fund like PFF or something instead of trying to pick stocks with high yields. They are high for a reason; and prices or dividend cuts usually follow. For example, see Macy's, which had a phenomenal dividend yield... until they suspended dividends altogether this year.

https://www.nasdaq.com/market-activity/stocks/m/dividend-history

Or Exxon:

https://www.bloomberg.com/news/articles/2020-04-29/exxon-freezes-dividend-for-first-time-in-13-years-amid-oil-rout

[ChpBstrd]

My first reaction is my experience and observation that yield-chasing is generally a horrible investment strategy. Dividends are paid by companies with no compelling use for their cash flow. They can't expand. Can't invest in new tech. Can't grow. So they slow-motion liquidate through dividends. Some are so bad as to pay dividends while also paying high interest on a growing pile of debt.

My second reaction is that if you lost your job or had to downsize your earnings, earning 5-6% on - what? - $30k or $40k is not going to move the needle much. Sure, a couple of grand per year helps, but it won't keep you from being homeless if you can't work. Plus there's the time it takes to amass this fund.

Assuming you have zero debt, here are what I think are better ideas to become more resilient to potential job loss, in no particular order:

1) Get a roommate: This pays at least several thousand a year. Maybe more in HCOL areas. This can also be the easiest option.
2) Lower your housing expenses: Buying a small, basic house in a LCOL area is often half the monthly payment as a rented apartment. Save up a down payment. This also makes #1 easier.
3) Lower your transportation expenses: You could have a very nice bike within a few months of saving spare money. Or pay for a move closer to work.
4) Invest in efficiency: If you own your home, insulation, storm windows, a newer fridge, or a new air conditioner could yield a competitive ROI.
5) Consider if you have landlord potential: You could save up a down payment on a rent house or duplex in a LCOL area. Some people get 10-20 properties and FIRE with very little equity. Just make sure the numbers work (in my city they don't).
6) Get certifications: These can make you more employable AND increase your income. E.g. a technical certification and a project management certification would go well with that MBA, but so would a healthcare certification and some legal training. Accounting is a good area to dive into when you're already in the banking industry.
7) Preventative maintenance: Bald tires, rusty plumbing, dust-clogged computers, worn out roofing, and HVAC systems that have never been cleaned/recharged are accidents waiting to happen. This is where $1 investment can save $10.

[MustacheAndaHalf]

actonyourown - Buying a few individual stocks is not diversification.  Even if you invest in a good dividend stock, March 2020 can come along and slice away 2/3rds the value of the stock at the same time they stop paying dividends.  So no income, and selling at a -66% loss.   Buying individual stocks entails a lot of risk, and isn't a good replacement for a savings account.

[Retire-Canada]

You'd be better off figuring out a side-gig you can get started on while working at the bank. If you come up with something that has the potential to scale with free time which would allow you to diversify against job loss.

You should also build up an emergency fund that covers 6 months expenses should you lose your job so you have room to breathe. I'm in Canada where we can access "retirement" investment accounts without issue anytime so once I had enough money invested I just used that as my EF so as to not have the cash drag of a large separate EF. I'm not familiar with how US retirement accounts work, but assuming you can access the money reasonably easy don't feel you need to keep the EF as cash in a savings account. OTOH if you do hold your EF as investments you'll need to allocate more funds to allow for some value lose if you need it when there is a market crash. Keeping in mind of course that those investments will grow and after a modest amount of time you'll have a buffer above the original value that can account for a crash.

I would also come up with an action plan that incorporates items such as the ones ChpBstrd mentions in his post. Having a written plan for what to do in the event you lose your job is helpful if you find the idea stressful. It gives you something to focus on and concrete steps to take.

Buying dividend stocks doesn't really diversify your income vs. looking at total return. And as ChpBstrd notes unless you are getting to the point where you are actually covering your core expenses having a few $K of dividends doesn't solve your problem and those dividends may well get cut right when you need them.

[actonyourown]

I see little difference between investing for diversified income and investing for retirement. Either is for generating income in case your earned income falls short of your needs. The only difference I see is that retirement is a choice based on expecting investment income to meet all future needs and your diversified income would be used if your earned income falls short for other reasons. This sounds like an emergency fund to me. Personally I'd just increase savings in retirement funds until using all the tax advantaged space. If funds are really needed, Roth IRA contributions can be withdrawn penalty free at any time.

I see your point that this may just be an emergency fund and cannot disagree.  It is in the manner that I would be putting money aside to grow or create income itself which would be higher than my high interest savings account because I do not plan on using this money unless I lose my job.  My goal would be to have it grow to earn a significant amount of money eventually once I have 6 months of expenses in my high interest savings account.

How would this be any different than from viewing a rental property netting $200/month without all the hassle of real-estate?

[actonyourown]

My first reaction is my experience and observation that yield-chasing is generally a horrible investment strategy. Dividends are paid by companies with no compelling use for their cash flow. They can't expand. Can't invest in new tech. Can't grow. So they slow-motion liquidate through dividends. Some are so bad as to pay dividends while also paying high interest on a growing pile of debt.

My second reaction is that if you lost your job or had to downsize your earnings, earning 5-6% on - what? - $30k or $40k is not going to move the needle much. Sure, a couple of grand per year helps, but it won't keep you from being homeless if you can't work. Plus there's the time it takes to amass this fund.

Assuming you have zero debt, here are what I think are better ideas to become more resilient to potential job loss, in no particular order:

1) Get a roommate: This pays at least several thousand a year. Maybe more in HCOL areas. This can also be the easiest option. I live in a one-bedroom, so not possible currently
2) Lower your housing expenses: Buying a small, basic house in a LCOL area is often half the monthly payment as a rented apartment. Save up a down payment. This also makes #1 easier. I am saving for EF right now and eventually will for a house.  I'm going to move in with my girlfriend next year which will lower my overall expenses (hopefully) and will allow me to max my Roth IRA at that time.
3) Lower your transportation expenses: You could have a very nice bike within a few months of saving spare money. Or pay for a move closer to work.  I live along the trolley line to work, but I work from home until the end of the year currently.  I drive about 7,000 to 8,500 miles per year in a paid for Honda Civic, so my costs can't go much lower now.
4) Invest in efficiency: If you own your home, insulation, storm windows, a newer fridge, or a new air conditioner could yield a competitive ROI. As stated, do not own my home but I do plan on doing these things when I purchase my first home.
5) Consider if you have landlord potential: You could save up a down payment on a rent house or duplex in a LCOL area. Some people get 10-20 properties and FIRE with very little equity. Just make sure the numbers work (in my city they don't). Will not be a landlord until I own my own house.
6) Get certifications: These can make you more employable AND increase your income. E.g. a technical certification and a project management certification would go well with that MBA, but so would a healthcare certification and some legal training. Accounting is a good area to dive into when you're already in the banking industry. I'm obtaining a certification in business analytics as part of a specialization of my MBA, but I can look into further education ideas.
7) Preventative maintenance: Bald tires, rusty plumbing, dust-clogged computers, worn out roofing, and HVAC systems that have never been cleaned/recharged are accidents waiting to happen. This is where $1 investment can save $10. I had mechanical maintenance performed on my car and it is running sufficiently well.

I appreciate the ideas for further savings.  I feel my largest issue to this point is increasing my income and creating a secondary source of income in case my employment ends.

[robartsd]

I see your point that this may just be an emergency fund and cannot disagree.  It is in the manner that I would be putting money aside to grow or create income itself which would be higher than my high interest savings account because I do not plan on using this money unless I lose my job.  My goal would be to have it grow to earn a significant amount of money eventually once I have 6 months of expenses in my high interest savings account.

How would this be any different than from viewing a rental property netting $200/month without all the hassle of real-estate?

I understand wanting an investment, rather than a side gig as a property manager. I don't see the advantage of foregoing tax advantaged space. I assume your plan is to work until you have enough total investments that you don't need to work again. Tax advantaged retirement accounts accommodate this nicely.

So far, you've indicated that you want a diversified income stream in case your earned income opportunities disappear. To me this is an emergency fund. You can use Roth IRA contributions penalty free. I imagine that Roth 401k contributions would also work, but I haven't looked into this as I only have traditional contributions to employer sponsored accounts. Should the emergency never come up (most likely scenario), your Roth investments just continue to grow tax free until you retire.  The only reasons I see for using taxable investments is 1) all tax advantage space is filled or 2) investments you want to make are not possible in tax advantaged accounts (i.e. self managed real estate). Sure, you could conceivably come to the situation where youve exhausted your penalty free Roth contribution withdraws and still need to pull money out of retirement accounts. If you're like most people on this forum, you're probably still better off tax wise because the difference between your barebones emergency budget effective tax rate and your full time work effective tax rate is larger than the early withdraw penalty.

[Financial.Velociraptor]

Options are my wheelhouse.  I think selling options for income makes a lot of sense many investors.  You should understand a few things though.

It is not a free lunch - part of what you are selling is your potential upside gains if the stock rallies.  Thus, you trade current income for future growth.

It can be time consuming.  If you are selling options on a small account and doing all the research and bookkeeping yourself, you might be better off with a second part time job at minimum wage.

The strategy doesn't lend well to indexing or use of ETFs.  Premiums are plumpest on individual stocks, especial ones with high "Beta".

Most of the members of the FIRE community will label you a heretic!  This one doesn't bother me, how thick is your skin?

Your most efficient time scale is about 6 to 8 weeks.  You'll be rolling positions about ten times a year.  Can you get a few minutes away from work 10 monday  mornings a year to do your trades?

Glad to talk individual options strategies via PM (I have two options heretics threads on this forum as well - or you can check my blog.)

[robartsd]

It can be time consuming.  If you are selling options on a small account and doing all the research and bookkeeping yourself, you might be better off with a second part time job at minimum wage.

Most of the members of the FIRE community will label you a heretic!  This one doesn't bother me, how thick is your skin?

I think these statements are related. It's not worth the time on a scale that is meaningful to most of the FIRE community.

[waltworks]

To clarify, @Financial.Velociraptor, this is both too time-consuming to do with a small account (though I'm not sure how small you mean) *and* simultaneously something you can do over 10 mornings/year? You'd only need to make a couple hundred bucks to get to minimum wage at 40 hours/year.

I have zero interest personally, sounds like work (and somewhat unpleasant/stressful work at that), but I'm curious about the numbers.

-W

[Financial.Velociraptor]

To clarify, @Financial.Velociraptor, this is both too time-consuming to do with a small account (though I'm not sure how small you mean) *and* simultaneously something you can do over 10 mornings/year? You'd only need to make a couple hundred bucks to get to minimum wage at 40 hours/year.

I have zero interest personally, sounds like work (and somewhat unpleasant/stressful work at that), but I'm curious about the numbers.

-W

The actual trading would be about once a month for a few minutes usually on the Monday following the third Friday, when standard contracts expire.  You should expect to do some additional research over the weekends so you don't just trade blindly.  For a beginner just learning what to look for, that research can be very time consuming.  For a few thousand a year, you can get a subscription to Retirement Trader at Stansberry and get two trades a month.  You'd have to put quite a bit at risk to cover the cost of the subscription but the education is probably worth it if options selling is compelling to you.

If it isn't, you should probably just index.  You can always buy a covered call enhanced ETF to have the best of both worlds. 

Honestly, since going FIRE, I've had almost a dozen people ask me how they should invest because they know I retired on a small stash and have made it work.  So far, after reviewing knowledge, risk tolerance, level of comittment, and more, I've told every one of them they should be indexing.  The amount of effort to learn how to trade right is probably better spent learning a new skill with market value such as copywriting.  I do it more because I love it than because it is the best way to make money out of all possible solutions.

[waltworks]

Makes sense. I think for me, what you're describing blurs the line between "investing" and "working" to the extent that I'd consider it a (well paid if done well) job.

-W