I’m dreaming of a 7 figure investment portfolio with a nice 5 figure portfolio income. I’m a few years from reaching that goal, but What is portfolio income compared to active income vs passive income? Which is the best type of income? in the market beats timing the market and I will get there eventually.
My ideal annual portfolio income is somewhere between $35,000 and $50,000. This is my ideal annual dividend income and my ideal withdrawal rate is 0%, or never touch your principal. If you’ve ever wondered what portfolio income is and how you can increase it, you’ve come to the right spot.
This post will go over what portfolio income is and the difference between active income vs passive income.
What is Portfolio Income?
Portfolio income is income derived from your investment portfolio. Your investments (the money you put in to generate income) Income sources of portfolio income are capital gains, dividend income, distributions, and interest income.
My portfolio income varies from month to month because most of the dividend paying companies pay out their dividends on a quarterly basis. Therefore, some months are stellar for dividend income and some months are not so exciting.
How to Increase Your Portfolio Income
You can increase portfolio income a few ways.
Invest More Money Into Your Portfolio
This is a given. If you deploy more capital (your precious hard earned money from your day job and side hustles) to your investments then this will increase your portfolio income. More moolah working for you means more money. You could set up a drip (for example, a Questrade drip) during the accumulation phase of your portfolio building to build more income producing assets.
Related: Tangerine Investment Funds Review
Focus on Portfolio INcome Rather Than Growth
If you are at a stage in your financial independence story where you are ready to focus on generating portfolio income rather than focusing on portfolio growth, you can switch off some of your focus from portfolio growth (e.g. investing in growth oriented exchange traded funds that don’t pay much in the way of distribution income, e.g. 2% yield) to focus more on portfolio income. Something so that your general portfolio yields at least 3.25% to 5%.
Choose Higher Yield Dividend Companies
When markets are down, there are more buying opportunities for excellent companies that just happen to have a higher dividend yield. To increase your dividend income you could opt for higher yielding dividend companies, though just be careful though as sometimes these payouts are not sustainable and then you get the eventual dividend cut, which inevitably ends up with investor panic and disdain and depressed share prices.
Opt for Dividend Paying ETFs
You can focus on dividend paying ETFs that have high yields. Dividend Earner has a very comprehensive Guide to Canadian Dividend ETFs including the MER (or management expense ratio), the annual return, and distribution frequency (for example, quarterly or monthly), and the net assets under management.
For example, XDV or iShares Canadian Select Dividend Index ETF has a yield of 4% (though it does have a higher MER compared to the other Canadian dividend exchange traded funds). Not surprisingly, XDV’s top 10 holdings are mainly comprised of Canadian financials.
Diversify with REITS
f you don’t have a lot of real estate exposure outside of your portfolio (many Canadians actually have too much real estate exposure because of their primary residence), diversifying your portfolio income with REITs is a great way to add regular income. For example, Riocan (REI.UN) pays out at least 5% annually and has over 230 properties with a total enterprise value of at least $14 billion. Dividend Earner again has a great comprehensive list of the Best Canadian REITs to invest in.
If you’re wary of investing in an individual REIT you can always invest in a REIT ETF, just be mindful of the MER associated with the REIT ETF which will eat into your income. I have a US REIT ETF (VNQ) and a Canadian REIT ETF (iShares S&P/TSX Capped REIT Index Fund (XRE.TO)) and I also have Riocan (REI.UN).
Prune Off Some Capital Gains
Of course, to increase your portfolio income, you can always prune off your portfolio and sell some capital gains, and basically create your own dividend.
Related: How Much Should I Have Saved by 40?
Focus on Reducing your Taxes On your Portfolio Income
Probably one of the most important ways to increase your portfolio income is to focus on reducing the taxes on your portfolio income. This can be achieved by making sure all your investments are in their most tax optimized location. Kind of like tidying up with Marie Kondo but for your tax advantaged accounts.
How to Decrease Taxes from Your Portfolio Income
As mentioned, to decreases taxes from your portfolio income and focus on increasing your income, you can decrease your taxes paid. In Canada, you can have up 5 figures of dividend income go untaxed if they are Canadian dividend eligible corporations and if you don’t have any other sources of income. However, be mindful of Canadian home bias with your asset allocation if you focus solely on Canadian dividend paying companies.
Taxes on Investments
As a basic refresher, here are the taxes on investment income in Canada:
- Capital gains from Canadian sources: 50% of the proceeds of disposition of your stock taxed at the marginal rate
- Interest income: 100% taxed at your marginal rate
- Canadian eligible dividends: Favourably taxed, according to Taxtips.ca, you can earn approximately $51,637 in 2017 before any federal tax is payable (if you had no income other than Canadian eligible dividend income)
- Canadian non-eligible dividends: Not as favourably taxed, but still not bad. Taxtips.ca says you can earn approximately $33,314 in 2017 before you have to pay any federal taxes.
- Foreign dividend income: Fully taxed at the marginal rate but can you can to get recover the foreign withholding tax
- Dividends from US corporations: There is a 15% foreign withholding tax on dividend income from US corporations
- US and foreign capital gains: The same as capital gains from a Canadian source, 50% of the proceeds are taxed at your marginal rate
For example, US dividend paying companies are best kept within an RRSP and Canadian dividend paying companies are happy to be outside of a registered account because the dividends are taxed favourably. I have a lot of Canadian dividend paying companies within my TFSA because no tax is better than some tax and I have just set it up like that and it’s hard to change course of action sometimes.
To summarize, increasing the income you get from your investment portfolio can be done in a number of ways, including shelling out more money to add to your portfolio (might be hard to do come financial independence time if there’s not much cash flow), or increasing the yield of the investments you have in your basket. Finally, focusing on reducing the taxes owed on your money earned is also an important way to increase your income in retirement and financial independence life.
Now that we know what portfolio income is and how to increase it, let’s go over active income vs passive income.
What is Active Income?
Active income is income generated from performing a service, according to Investopedia. For example, you worked in retail at the local mall for $9.50 an hour when you were 16. You exchanged your time and services (selling skills, marketing skills, customer service skills) for monetary compensation. That $9.50/hour generated is considered active income.
When you are working your 9-5 Monday to Friday job that’s also considered earning an active income. Many people dream of achieving financial independence and retiring early so that they don’t have to work the 40+ hours a week to earn their active income. You can also earn active income from selling products or goods as well. For example, active income generated from businesses is considered active business income. For more information, Taxtips.ca has some useful information on setting up a corporation for active business income.
Active income is taxed differently from passive income in Canada. Generally, passive income is taxed more favourably than active income.
Many individuals are not interested in working for 25-40 years for 40+ hours a week because they would rather spend their time how they wish. They would rather reach financial independence and retire early and not exchange their time and services for monetary compensation on someone else’s terms (e.g. your employer).
Related: The Ultimate Recipe for FIRE: Financial Independence Retire Early
When you are so disenfranchised with how much work, effort, and energy it takes to work and how little time and energy you have left for yourself, you will end up having the motivation to increase your passive income. It’s one of the ways you know you have reached adulthood.
That being said, some active income ideas that are considered less taxing than a 9-5 cubicle soul sucking existence are active income sources like:
- Driving for Uber
- Managing and cleaning and renting out Airbnb
- Delivering for food delivery companies like Door Dash
- Pet sitting or dog walking for Rover.com
What is Passive Income?
Not surprisingly, passive income is my favourite form of income. Passive income is income generated with minimal or zero effort. There may be effort generated initially to set up the passive income but after the initial set up, passive income requires very little effort.
Passive Income is LOW MAINTENANCE.
Some forms of passive income include (my all time favourite passive income stream) dividends. Dividends are distributions of a company’s earnings to the shareholders. They are consistent (as long as the company is doing well and doesn’t cut their dividend payout) and reliable, just like the ocean waves.
Related: 9 Ways to Earn Passive Income In Canada
Another source of passive income is interest income. It’s even more passive compared to dividend income but definitely not as geared towards growth. Interest income is generated from your savings in a savings account.
Related: 9 Income Producing Assets to Achieve Financial Freedom
Another source of passive income could be from real estate income, especially if you hire a property manager (I wouldn’t call it passive if you do it yourself as the property manager).
Investing in REITs (Real Estate Investment Trusts) is even lower maintenance than collecting rental income and hiring a property manager.
Passive vs Active Income
Some sources, like business income or even income generated from a blog is debatable whether it is active or passive income.
Joe from Retire by 40 does not consider blogging to be passive income. For example, display advertisement on a website property is passive income technically– but you have to maintain the blog, e.g. continue writing regularly, continue marketing regularly in order to sustain traffic. However, to ‘maintain’ it, it is flexible and can be done at varying times and not from a cubicle between the hours of 9-5. Nonetheless, blogging can be very difficult to start up and takes a lot of time and effort (and ACTIVE work for no income, at least in the initial stages- with the initial stages duration varying greatly).
Generating a ‘side hustle’ of passive income of say, $800 a month is somewhat equivalent (minus the taxation difference) to generating $800 a month in dividends but instead of hours and hours of blood sweat in an attempt to create the $800 a month, you would need a monetary investment of $274,300 generating a 3.5% annual dividend yield.
So there’s a trade off- exchange time and effort or exchange hard earned money from your active income for absolutely zero effort? Personally, I think it’s a good idea to try and diversify your income streams in order to build wealth, whether it is active or passive income, it’s still income. In fact, Inc.com states that 65% of self made millionaires had three streams of income and 45% of self-made millionaires had four streams of income.
For dividend or passive income, you trade off your MONEY for more TIME (because the income you generate will give you more time if you don’t need to actively work to make income for your lifestyle). For more worked income, you trade off your TIME for MONEY.
What do you think of active income vs passive income?
Would you rather dividends be comprised of your portfolio income in retirement or capital gains?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.