Should you invest in growth assets or accumulate passive income assets? — or both?
I’m pursuing both at the same time. Here’s why.
Disciples of Robert Kiyosaki’s book, “Rich Dad, Poor dad” are very likely to give a definite passive income first answer.
Why? — Because according to the “rich dad”, to obtain financial independence, the goal is to accumulate as many income-producing assets as possible until the income from these assets is sufficient enough to pay for one’s living expenses. Hence, passive income first.
On the other hand, followers of the FIRE movement might place a higher priority to invest in compounding assets that help to grow at a higher rate. It speeds up the journey to retirement and helps to achieve their ideal portfolio size for a yearly 4% withdrawal rate.
Although both ways are different, the goals are the same — that is to achieve financial independence and to get out of the rat race. While both ways are useful pointers, each has its own pros and cons.
Investing in high growth assets
High growth assets are usually more volatile, and require taking on more risk but have the highest potential. For example, a common high-growth asset is growth stocks companies that do not pay out any dividends but reinvest their earnings for higher growth in profits in the future. Or it could just be building and expanding your own scalable business from scratch.
- Investing in high-growth companies or expanding a scalable business is able to provide a greater compounding effect. Income earned is not taken out at all. Instead, it's automatically used to reinvest back into the company or business.
- Able to grow a small portfolio or expand your initial capital at a faster pace.
- Has a lower tax rate due to long-term capital gain and corporate tax rate.
- Highest potential to build long-term and generational wealth instead of gaining a high income.
- Lower recovery period (that is if, the capital invested is manageable)
- Able to outperform inflation. As inflation increases steadily on a yearly basis, so do your investments! (but at a much higher rate!)
- Tends to take on higher risk due to its volatility.
- Potential to lose entire capital invested.
- No income is given to supplement your living expenses. You’ll still need your day job or a bigger portion of an emergency fund is needed for business owners.
- Expect to pay a premium for investing in growth stocks.
- Expect to hustle or endure cash-burning activities at the early stages of a business.
Generating passive income
Passive income sources are usually more stable, hence lesser risk but come with a trade-off of lower returns as well. Examples of passive income assets are dividend index funds, REITs, annuities, or rental income from property investment.
- Provides a consistent income needed to cover living expenses without needing to work.
- Lesser risk is involved due to investments toward stable asset classes that provide basic necessities such as consumer staples and estates.
- Capital preservation is a top priority.
- Lesser work is needed to monitor or maintain your portfolio and capital.
- A big portion of investment capital is needed for the passive income received to be of a significant amount. Imagine having $330 per month on a 4% return from a $100,000 invested. Although it could supplement a portion of your living expenses, it’s still insufficient.
- Takes a longer time to reach financial independence from a small or middle-income class. No budget can help to speed up the process.
- Not ideal for building wealth — only preserving it. As living expenses increase due to inflation, a bigger portion of capital is always needed to keep up with inflation.
- Taxed at a higher rate. Ordinary dividends are treated the same as income tax and are taxed at the current income tax bracket level.
So with a clearer perspective of growth assets versus passive income assets, it’s pretty clear that growth assets as the name suggest help to grow wealth at a fast pace but leaves more room for error and mistakes.
On the other hand, while accumulating passive assets might be attractive to most people as it does not require much work or some might mistake it to be a “no work at all” kinda thing, it leaves out the opportunity cost of compounding to take place.
While I’m all in for passive income, I do think that focusing on investing in high-growth assets such as growth stocks places a higher priority for me currently.
Reasons for investing in growth assets first.
i) There are still plenty of years ahead for me to grow my investments and let compounding take place.
ii) I’m still in the wealth accumulation phase and not in the wealth preservation phase. Some might place too much emphasis on accumulating passive income assets that it clouds their mind and they miss out on the opportunity of the 8th wonder of the world — compounding!
iii) Being in a middle-income group, there is a limit to how much I can save. So, the faster route to expand wealth is to invest in growth assets.
iv) By keeping myself updated with the current economic happenings, company news, and investment plan and increasing my financial literacy, I am more confident to invest in higher-risk assets while having risks taken under control.
Reasons for accumulating passive income assets but secondary.
i) It provides me with multiple sources of income for a better “peace of mind” and not relying too much on my emergency fund should I be let go from my 9–5 job.
ii) It helps to build up my earnings which contribute to a higher savings rate that is invested into growth assets.
iii) Take advantage of leveraging other people’s money (aka banks) to increase my earning power.
Hope this gives you a critical reflection on passive income and positive enlightenment on investing in growth assets!
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