The new component in building passive income strategies

Attempting to build a diversified portfolio of assets that provides consistent income, is nothing new as an investment approach. For as long as people have invested, generating consistent cash flow has been a well sought ideal to cover the cost of living. 

What is passive income?

A passive income stream is an income source you can generate from your invested capital. Simple mathematics says the larger your asset pool the more passive income it will generate. However, the majority of investors have a finite volume of capital to invest, so making the most out of their passive income stream is important.  

The most common ways investors have tended to build their diversified income streams have been the following: 

1.         Interest on term deposits;

2.         Real estate providing rental proceeds;

3.         Shares providing dividends;

4.         Bonds providing coupon payments.

If we take the view that interest, rents, dividends and coupons are the four most common sources of income streams, alternatives (or alts) can now be viewed as the important “fifth component”.  Alts are the fifth key member to passive income investing.

Alts are being utilised by a wide variety of investors for their differentiated income streams, from the largest institutional investors right through to private individuals. 

Some key considerations for investors to consider when building diversification across the income stream being generated by a portfolio, can include the following:

• How resilient are my income streams to the changing economic circumstances?  i.e. are all my cash flows decreasing when the economy softens or is only a section of my portfolio affected?

• If interest rates officially move lower, are all income streams correlated and negatively affected?

• How much income do I want and need to achieve per annum? And how much capital will I need to invest to achieve my desired income level?

• What are my real income streams paying me after I consider the costs related to owning that asset?

When investor’s are considering alts as their “fifth key member,” they can be of the understanding that some income streams generated in the sector can have lower correlation to the economic cycle than some other asset classes.  They can also benefit by having a mix of fixed and floating rate exposures, and a sound understanding of their true after costs income. 

Investors should focus on the experience, skillset and diversification of their investment managers in their alternative allocations.