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Seven steps to creating passive income from the stock market.

Saturday, February 27, 2010



I have made it known to my family and many friends that I aim to create a minimum of $50k in annual passive income from investments in the stock market alone.  Recently, while chatting in the cbox at Bully the Bear, I mentioned this and at least one person was incredulous.  How to achieve this?

Well, to me, it's quite simple, if I invest $500k in a basket of stocks that yields 10% per annum, I would have that $50k passive income.  Then, I gave it some thought later  on and decided that perhaps I should share more in detail how this could be achieved.

Taking a leaf from successful authors using the number "seven", this is AK71's "Seven steps to creating passive income from the stock market":

1.  Get full time employment - Sounds dreadfully straightforward, doesn't it?  Well, sometimes we need to point out the obvious.  We cannot grow money in pots of soil or fabricate it at home; well, not legally anyway.  Get a well paying job that pays you as much as you are worth (or more than you are worth if you are lucky enough).  Don't shortchange yourself.

2.  Be frugal - Again, this sounds straightforward enough but it is something that many people find hard to do.  Instant gratification is so common in our modern world, isn't it?  I want something and I want it NOW!  It is quite well known that George Soros takes the subway to work and that the founder of IKEA is still driving the same Volvo he bought more than 20 years ago!  I blogged about this recently.
Money management: Needs and wants.

3.  Save as much as you can.  OK, I'm cheating here.  This is really a combination of points 1 and 2.  Make as much as you can in your full time job and spend as little as you can.  The difference: savings.  This is your initial capital to realise your dream of passive income from the stock market.  Also, remember, money in your CPF-OA is savings and a percentage could be used to invest in the stock market too.  Start a SRS account and use the money to invest in the stock market at the right time.
Things Singaporean: SRS, CPF-OA and CPF-SA.

4.  Fundamental Analysis (FA): go learn FA if you have not done so already.  This is very important in the identification of good companies in your quest to build a passive income stream from the stock market.  This cannot be emphasised enough.  Look for companies with high yields but ensure that they have a strong balance sheet and good cash flow.  Do not look at the income statement only.  Otherwise, it might come back to haunt you.
Fundamental analysis: The income statement.
Fundamental analysis: Balance sheet.
Fundamental analysis: The cash flow statement.

5.  Technical Analysis (TA): go learn TA if you have not done so already.  If FA tells you a company has a fair value of $1 and the price is now 80c, is this good enough to buy?  Well, if the company's share price is going through a downtrend, no.  Cheap might get cheaper.  That's what TA can do for you: it shows you the trend, resistance and support levels.  FA cannot do that.  Market sentiments do not care two hoots what is the fundamental value of a company and you will do well to remember this.
Thoughts on methodology.

6.  Invest in the good companies you have identified and monitor them constantly.  There are quarterly and annual reports to analyse.  Use FA to ensure that they are still doing well and likely to continue doing well in future.  Use TA to check on the longer term trends. 
Identifying trends and value: FA and TA.
Risks and rewards: TA and FA.
Monitoring our stocks.

7.  Reap the rewards of your investments and collect the dividends.  Yes, finally, we get to the fun part!  You can decide if you want to use the dividends to reward yourself or if you want to add to your pool of savings to be re-invested.  Of course, if you want to achieve a higher passive income within a shorter period of time, re-investing is the answer.  Just employ FA and TA again to do this.

In the meantime, if you did not get retrenched (knock on wood), ensuring that you continue to save as much of your earnings as you can from your full time job will continue to grow your pool of savings even as dividends received from your investments pour in.  Year after year, your annual income increases through greater contributions from the passive income received through your well thought out investments (everything else being equal).  Sounds really good, doesn't it?

Before long, you would have a significant stream of passive income supplementing your earned income from employment.  After some time, your passive income might equal your earned income and that's when you work because you want to and not because you have to.  Now, if this does not convince you, I don't know what will.

It is definitely possible to create a significant passive income stream from investing in the stock market.  Like so many things in life, there is just no short cut though.  So, if this is your dream just like it is mine, get cracking.  Good luck.  Yes, you will need some of this too.

Finally, remember, if you find some good companies out there which the analysts haven't discovered yet, come back here and share with us.  This is most important.
Stock market analysts.

P.S. For the sake of brevity, "companies" in this post refer to REITs and business trusts as well since these are primarily dividend instruments and must be considered in our quest for passive income from the stock market.

Related post:
Recommended books for FA and TA.

48 comments:

RL said...

Tks for the constant good posts. I quite like your strategy so have been following.

You mentioned about putting $500k in stocks. I am wondering, if I really have $500k cash at hand, would I take a major part to pay for the downpayment of property, or should I be putting them in stocks? What do you think?

AK71 said...

Hi RL,

Thank you for the compliments and I am glad you like my little big ideas. ;)

If you have $500k in hand, should you take a big part of it to pay for the downpayment of a private property or put all of it in high yielding stocks? I like this question.

You might have read my posts titled "Grow your wealth and beat inflation" and "Real estate as a hedge against inflation". In these posts, I spoke about how real estate should play a part in our overall strategy, if possible.

As with stocks, it is important to time your property purchases correctly. More so because the quantum in property purchases is a lot bigger and you would probably be taking a loan for a large portion of the property's value. So, any mistake would be magnified.

Furthermore, unless we are multi-millionaires, one mistake in a property purchase might be financially crippling as we might not have the resources to ride out any rough patches.

With property, people say it is location, location and location. This is largely true. If you time your purchase correctly, you will have a winner.

Timing? It is not magic. Consider purchasing properties when showflats are more or less deserted (ie when people are too afraid to buy). Find a property you like, keep visiting the showflat and keep talking to the agents. Prices might go lower. When you see the crowds returning, that would be a great time to buy. Things are turning up but won't turn up overnight. So, you would have a window of, say, two weeks to act.

If you think this is a good idea, share with your friends. Everyone should be responsible for their own financial security and if my ideas help in any way, I'm happy.

Gohsip said...

Hi AK,

I'm working towards this goal as well.
Right now, with the little capital that I have (Bought an apartment, and spending money on my wedding), I'm very focused on point one; full time employment income.

I plan my career. I make sure I pick up valuable skillsets in my line of work; skillsets that are transferable. I managed to rotate around and am now working in my third team in a short span of 2 years with my current employer. This makes me more valuable within the firm. It has also upped my market value in the industry.

My career is now my priority. Not investing.
I think most people get the concept wrong. They dread going to work, they want to get rich quick. They want to make a fortune from the stock market or flip properties like roti prata. The don't aim to climb the corporate ladder. I can safely say that this concept is wrong.

I enjoy going to work. I love challenges. I don't mind the long hours. I don't mind the stress. I manage the politics. I think we should work hard and not keep thinking of ways to stop working.

Cheers

Raelynn said...

Hello! it's the first time that i'm reading your blog =) I too feel that your blog entries are much clearer and easier for beginner investors to follow as compared to other financial investment blogs. I am currently still waiting for LMIR to fall... *cross my fingers*

May I seek your comments on First Ship Lease Trust??

AK71 said...

Hi Gohsip,

Without capital, there is no need to talk about investments in any form. Accumulation of capital requires something predictable. For most people, that predictability comes from having a full time job.

So, you have your priorities in the right order. Everyone should start from point number one unless they are born with a silver spoon in their mouth.

You sound like a very driven person and your company seems to be treating you well. You have point number 1 covered. :)

As for your last paragaph, my take is that we should work hard but we should also work hard planning for the days when we would, should or could stop working. We need to have knowledge of the ways that would help us achieve that. That's what my blog is about. ;)

I always enjoy our chats in LP's cbox. Very happy to see a comment from you here. I look forward to hearing from you again. :)

AK71 said...

Hi Raelynn,

Newcomer? Welcome to my den of little big ideas. I'm glad you find my writing style digestible. :)

Waiting for the price of LMIR to fall before accumulating is a good idea. I am waiting for it to correct to 46c before buying more. However, that is just TA showing us where is the next support. It might or might not happen although in the current environment, it seems probable. Anyway, I always hedge.

As for FSL, I have some units of this bought at prices I would rather forget. One of my mistakes in the past. Shipping is a tough business but I won't go into details here. I dislike the idea that their assets are depreciating in value and this is independent of global economic performance. Having said this, I believe that the outlook for FSL has stabilised for now and the probability of nasty surprises in the near future is low.

Thanks for visiting and come back often. :)

la papillion said...

Hi AK,

Concur with Goh too. Work hard in career is very important to generate the capital. This comes together with saving hard.

I know people who earns so much but spends equally as much. This is what they call in physics - having a distance travelled but zero displacement.

AK71 said...

Hi LP,

Yup, I blogged about this in a recent post as well: "Money management: Needs and wants."

Make $10k a month but spend $10k a month, back to nothing. Make $10k a month and spend $12k a month, formula for disaster.

My knowledge of Physics stopped at "O" levels and it wasn't one of my best subjects but I get what you mean. ;)

AT said...

Hi AK,

Thank you for your informative blog posts! I came across your blog while searching for news on Saizen REIT's YK Shintoku loan. I am vested in Saizen REIT 2012 warrant since Sep 09, and I am accumulating even more.

Like you, I am a believer in high-yield stocks and I have the same goal - to gain financial independence through investments in high-yield instruments.

Re your post today, I might just add that there are quite a number of stocks that are have dividend yields comparable or better than the REITS/Business trusts you listed above (Starhub, Innotek and Global Invest being three examples).

I look forward to reading more of your posts in the future!

AK71 said...

Hi AT,

At the current prices, could you share with us the yields, the gearing levels and the NAVs of Starhub, Innotek and Global Invest here? These are the criteria I use to pick out good investments in REITs. So, we want to compare using the same financial yardstick.

I'm glad you like my posts and I look forward to hearing from you again. Thank you. :)

Anonymous said...

AK71,

As of Mar 1 closing:

Innotek - close 42.5c, Div Yield 11.8%, NAV 86.0 c. Debt vs equity ratio 0.694

Starhub - close $2.15, Div yield 9.3%, NAV 7.34c Debt vs Equity ratio 12.8

Scary-looking figures for Starhub's NAV and gearing are a function of their asset-light business model rather than an indication of the viability of their operations.

Innotek has declared 5 cents dividend for FY09 (same as FY08) plus a share buyback scheme which should provide some buffer against downward price swings in the short term.

I will not list out Global Invest figures here - just last night I had a rude shock reading their FY09 asset review slides and have decided against investing in this counter.

AT

AK71 said...

Hi AT,

I read the report on Innotek by Kevin Scully (NRA) in Next Insight earlier today. I think you might have a winner here. It's definitely a value proposition.

As for Starhub, I have been wary of it despite its high yield because of its nightmarish gearing level. Should an asset light business model have such high gearing? Capitaland is asset light with all their divestments but they don't have massive debts, do they?

Perhaps, I do not understand Starhub's business and I try to make it a point not to invest in businesses I don't understand. If you would like to share more of your insights here, please do. I'm very interested.

Regarding the rude shock you received from going through Global Invest's figures, if you could share it here too, I would be much obliged. After all, we should learn what are the kind of companies to avoid as well.

Thank you very much for taking the time to share. :)

Anonymous said...

Just happened to stumble on this blog from finance.sg
It s a very good financial management website. Yeah, i have tried the the seven steps to create a passive income. It works, at least in the sense that I managed to have a 600K portfolio using the first few steps mentioned. It shows we can be financially independent even when we start out poor.
But on another point, to get a 50K annual dividend is very difficult using this portfolio.
I dont like REITs; I think they are too cash hungry. Too much debt and too ready to raise funds from shareholders. Any inability to refinance debts is a huge threat.
I like Venture Corp, SPH, M1 for their dividends. I keep them (or used to keep them) in my portfolio, but the yield is around 7 percent. And these are just part of the portfolio. There are many stocks such as Citigroup that dont give out dividends and this brings down the overall portfolio yield lower.
That is why I think, in order to get 50K dividend on a yearly basis, I wlll need a million bucks.
Just my thots.

AK71 said...

Hi,

Thanks very much for sharing your thoughts on the subject.

With regards to REITs, it is probably right to say they have been tarred with the same brush, very much like S-chips. We hear how people no longer trust S-chips as well.

There might be some good members in the group which might unjustly suffer the same negative discrimination through no fault of their own. It becomes too easy to stereotype.

That is why I have crystallised a set of guidelines which, if followed closely, should find us strong, dependable REITS to generate high yields, contributing to our passive income stream.

Ultimately, it depends on one's comfort level with different strategies available. If you no longer feel comfortable with REITs, it is probably best to leave them out of your portfolio. Peace of mind is priceless. :-)

Marco said...

Hi AKs, I started to invest in SGX a week ago. I am going to invest in REITs only because of its stability and dividend yield. The first REIT I bought is AIMSAMPIReit at SGD0.205.

We have something in common, which is I believe in generating passive income via equity, and REITs is one of the answers.

Apart from AIMSAMPIReit, I am also looking at Sabana, LippoMapleT & Fortune Reit.

I am a beginner in S-REITs, do hope to see your review on the above REITs.

Thank you.

AK71 said...

Hi Marco,

I have blogged quite a bit on LMIR and First REIT. If you use the search function at the top of my blog, you should be able to find the blog posts.

As for Fortune REIT, I do not invest in counters denominated in a foreign currency. So, I have not even bothered to look at it. Gotta pass on that one. ;)

Good luck to both of us. :)

AK71 said...

Hi Marco,

I do not know why "First REIT" came into my head. I should have said "Sabana REIT". My apologies.

I have blogged extensively about Sabana REIT as well. Use the search function at the top of my blog or go to the box on the right sidebar that says "Investing in REITs and Business Trusts". Happy reading. :)

Marco said...

Hi AK71,

Thanks for all the effort...

K-Enterprises said...

Hi AK71!!!

I am a big fan of your blog since stumbling upon it a few months ago. Sorry for not leaving a comment earlier.
I had moderate positions in AIMSAMREIT and Sabana REIT but however made mistakes by investing in two REITS too early. Mainly Suntec @ $1.27 and CapitalCommercial @ $1.26. What is your advise with regards to this two REITS!

AK71 said...

Hi K-Enterprise,

I have a smallish position in Suntec REIT left, having divested the bulk of my investment over the last two years. I had a position in CCT too which I divested completely.

I made some nice capital gains divesting the investment in these two REITs and decided that industrial real estate would be more rewarding.

I am not too sanguine about office space rentals in the next few years as a lot more space will become available. Office landlords also face competition from high tech industrial space landlords.

A third of Sabana REIT's portfolio is high tech industrial space while a fifth of AIMS AMP Capital Industrial REIT's portfolio is so.

In a recessionary environment, demand for industrial space is relatively more inelastic compared to demand for office space. Tenants of office spaces are usually relatively more footloose.

Just some of my thoughts. I am sure you will do your own due diligence. ;)

zhic0ng said...

Hi AK71,I am 19 year old poly student. Do you 7step apply to student as well? Good stock that paid good dividend dont come cheap. Can student earn passive income too?

AK71 said...

Hi Zhic0ng,

I feel that anyone can generate passive income from the stock market.

You might be interested in this blog post:
At what age to start investing in the stock market?

What is good and what is cheap? You have to decide on the valuations yourself, of course.

Is a $1 stock cheaper than a $10 stock? Is a counter with a 10% distribution yield better than a counter with a 4% dividend yield?

Finally, yes, the 7 steps I have outlined in this blog post are simple enough for anyone to follow, even full time students. Step 1 will have to be amended, of course. Part time employment? Why not? ;)

Unknown said...

Hi AK71,

Thank you for sharing your knowledge and showing us that it is possible to earn sufficient passive income to live on when we retire.

I'll like to know your recommendation for FA and TA book/s. Also, is there any seminar or classes that you highly recommend? I've been researching on a basic class where I can learn the "rules of the game". Wish the universities would conduct such classes.

Thank you
tt

AK71 said...

Hi tt,

I am self taught. So, I cannot recommend any courses, having shunned them and saved thousands of dollars in the process. ;)

If you are just starting out on TA, the DUMMIES series is actually quite good. There is a general one on Technical Analysis and one on Candlesticks Charting. Then, if you were to move on, there is a book by Michael Kahn called "Technical Analysis Plain and Simple".

For FA, I like "Warren Buffet and the Interpretation of Financial Statements". Really easy to digest.

You might want to try ordering the books from BetterWorldBooks. They ship free worldwide. Here is the link to my blog post on them:

BetterWorldBooks.

Happy reading. :)

AhJohn said...

Just reserve the book "Warren Buffet and the Interpretation of Financial Statements" from National Library, thanks!

AK71 said...

Hi Ah John,

Borrowing books from the library is greatly encouraged, I am sure. Hope you enjoy the book. :)

Personally, I have not borrowed a book in many years. I like to keep good books near me for easy reference.

As an aside, on my infrequent visits to the public libraries with my niece, I was impressed with how public libraries look like these days.

tt said...

thank you =)

side topic : is there anywhere on your blog where I can drop a short note like thank you without taking up space on your comments section?

AK71 said...

Hi tt,

That stumped me... I don't think so. Maybe, someone would have an answer to this. I am a rather new blogger, you see. ;)

AhJohn said...

now you can reserve a book and request them to transfer to the Library that you choose and reserve for you, if the book is available for collection, they will inform you. Very convenient, with $1 plus cost only.

AK71 said...

Hi Ah John,

Thanks for sharing this. I guess I could try it out one day although the probability is rather low that I would. ;p

Ah John said...

I have read the book, good! Thanks, AK!
Any more recommendations?

AK71 said...

Hi Ah John,

It is definitely one of the more readable books on FA and Warren Buffet's investment approach. I am glad you like it. :)

I have not been reading any books on FA for many months now. I have been lazy...

Yi Fong Tan said...

Hi AK, can you do a post your opinion between investing in REITS vs property? Or if you already have one, can point out the link to me? Thanks!

AK71 said...

Hi Yi Fong,

Whether to invest in REITs or directly in properties or both largely depends on individual risk appetite and resources available.

Here is a link to a balanced article on REITs:
REITs.

I don't think I can do any better. :)

What about investing directly in properties?

Investing directly in properties, the biggest advantage is having the use of financial leverage which could result in a higher return on investment (ROI).

Apart from this major advantage, I do not see why investing directly in properties should be preferable to investing in a few well run REITs.

Capricon said...

Hi AK
Just stumbled to your blog from some other SG investments blogs and I'm glad I did.

1. When and How do you take the decision to divest ? Majority of your investments are for passive income, divestment means that you might be getting the same stock at a higher price later even though there could be a stock market dip.

2. Upon divestment, would you reinvest immediately ? Else that means losing the passive income too.

3. Do you do analysis such as finding intrinsic value of a company using discounted cash flow etc ? Some value investing courses out there advocates such analysis, the course fees are not cheap for just couple of days.

Btw what is this LP cbox you mentioning, how can I get onto it ?

Cheers

AK71 said...

Hi Capricorn,

1. Sell when an investment is no longer worth loving.

See:
a. Do not love unless it is worth the loving.
b. 5 steps to take in REIT investment.
c. 2012 full year passive income from S-REITs.

2. There is nothing wrong with holding cash.

See:
a. If we want peace, be prepared for war.
b. AK71's simple strategy.

3. Some people learn better attending courses. So, it is really up to the individual.

See:
a. Tea with AK71: An audio interview.
b. 5 rules for successful stock investing.

Visit "Bully the Bear" and you will see LP's cbox.

I am glad that you are glad to have discovered my blog and I look forward to hearing from you again. :)

Caprio said...

Hi AK,

I am just a fresh graduate and have not my than 2 years working experience. Glad that I found your blog here.

May I know how long does it take you to have 500k capital? Also, I personally I find it tough to have 10% dividend payout a year from investment.

Thanks,
JW

AK71 said...

Hi JW,

There were windows of opportunity for 10% dividend/distribution yield and even higher. Right now, I don't see any. :(

You must have a war chest to deploy every time a window opens. Hence, the importance of saving regularly and meaningfully. :)

I cannot remember exactly when I got to $500k in capital but in my early years, I was saving $20k a year and it slowly increased. The initial years were the toughest.

I believe that with the much higher starting pay of graduates these days, you guys can progress at a faster clip. :)

boonchin.ng said...

Hi Ak71,

Thanks for the great post. Start learning stock investing merely 3 months ago and still too much to learn.

As a newbie, always having difficulty finding the "right" time to buy. What should be the "strategy" then? Take Super Group for example, the price appreciate quite a fair bit from $2+ to $4+ now. Should wait for the "correction" or buy now and average down? The "correction" could be next week, 3 months later, or 2 years late, can't predict Mr. Market mood.

Hope I'm asking a sensible question. Any appreciate your advice :)

AK71 said...

Hi boonchin,

You might want to read this:

When to BUY, HOLD or SELL?

Don't be too caught up with "prices", you have to consider the "value". ;)

Of course, if you are interested in price action, then, you want to learn Technical Analysis (TA).

Some books could be helpful:

Recommended books for TA.

Know yourself and create your own path. :)

boonchin.ng said...

Hi AK71,

Thanks for the reply :) well, I'm more interested in generating passive income. Managed to get a few lots AIMSAIMP @ $1.335 which translate to good dividend yield.

But always bothering me is, should I continue buy more AIMSAIMP for example, or should keep the cash and wait for next "$1.335 opportunity"

Still discovering my path, but love your idea using both TA (find good fundamental company) and TA (good entry / exit price).

Thanks!

AK71 said...

Hi boonchin,

Buying more AIMS AMP Capital Industrial REIT at $1.33 was a good move. Basically, that was a 10+% discount to NAV and a good 8.3% distribution yield. ;)

I wouldn't say what you should be doing but I like buying at a discount to NAV when it comes to REITs. ;p

boonchin.ng said...

Hi AK71,

Thanks for replying. Just noticed there were typo in my previous comment. Should be AIMSAMPI, and FA for finding good fundamental company :)

AK71 said...

Hi boonchin,

No worries about the typo. I kind of figured it myself. ;)

slacker said...

Thanks for sharing ur great thoughts. We are working towards that goal too. Spend less, save more. A lot of times, we just buy things for others to see what we can afford. I'm hoping to retired by 40 and get a lifestyle job. Why are u still working if ur passive income is much more than u make as a salary man? Lost 10k$ previously in the market, just follow blindly. Now I'm more prudent. I like what u share, it really insightful, and easy to digest (I'm very thick when it comes to working my brain) . Very nice blog.

AK71 said...

Hi slacker,

Sounds like you have not been slacking at all. For sure, being financially prudent is one of the first steps towards financial freedom. It should be one of the simpler steps to take but for many, it is still quite a challenge. So, gambatte! :)

Once we have our desired level of passive income, we can choose to work because we want to and not because we have.

Work because you want to and not because you have to.

However, I have blogged or commented before that it is not quite so easy as we will discover later on.

There will be reasons why we might not want to quit right away especially if we have built good and strong relationships at work over many years. For a while, I was also worried if my passive income would be sufficient to take care of my parents and possibly my sister and niece as well (and I decided that it wouldn't be enough). I think a lot. Some say I think too much.

I am glad that you enjoy my blog and if you have found it helpful in the slightest bit, that is good enough for me. :)

Nicole said...

Thanks for the great article! I just graduated and started to invest in REITs.

Though my REITs prices are dropping, I still hope that they will be able to bring me passive income. It is quite a scary experience because I just started doing this and unlike the conventional way where my parents would only encourage me to buy and sell and go.

It is very encouraging to know that you buy and hold REITs and receive passive income!

AK71 said...

Hi Nicole,

I have quite a few blog posts on REITs. I hope you will find them helpful on your journey towards financial freedom. ;)

If we want to invest for income, we would not go very wrong paying fair prices for bona fide income producing assets. Gambatte! :)

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