Are you starting off with $25,000 or so, and hoping to build a passive income portfolio?
If the goal is to live off your passive income, you’ve got a long way to go: it takes over $1 million invested at the TSX market yield to cover a typical Canadian’s annual living expenses.
If, on the other hand, your goal is to get started on a passive income portfolio that you could eventually live off of, you’re in luck.
With just $25,000 in starting funds, you can easily build toward a tax-free TFSA that can cover your living expenses someday. While you wait, you might start off collecting a few hundred dollars worth of passive income per year. In your first year, you could earn $500 or more – easily!
It takes just four simple steps to start building a passive income portfolio with just $25,000. So, let’s jump right into it.
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Step 1: Choose your environment
Before you invest in anything, you need to know where you’re going to hold the investments. If you’re a typical working-age Canadian, the best place is likely some kind of retirement account. The tax-free savings account (TFSA) lets you contribute, invest, and withdraw funds tax-free. The RRSP is similar to the TFSA, but taxable on withdrawals, and provides a tax deduction on contributions. Where you choose to invest is a matter of preference. The simplest environment to get started in is a TFSA, because the TFSA’s tax rules are simpler than the RRSP’s.
Step 2: Choose your asset allocation
Your asset allocation is how much you’ll put into various categories of assets: stocks, bonds, real estate, etc. Since this article is about retirement saving, I’ll ignore real estate, which is primarily a lifestyle investment. Basically, you need a certain percentage of your money in stocks for long-term gains, and a certain percentage in bonds for liquidity. How much you need in each category depends on your situation. If you are 100% sure your job will cover all your expenses for all your working days, you could put as much as 100% in stocks. If you are retired, disabled with no ability to work, and holding $750,000, you may want to protect up to 50% of your net worth in bonds. Given that you are starting off with $25,000, I will assume you’re still working and suggest that 60%–80% in equities, and 20%–40% in bonds, is best for your needs.
Step 3: Pick your securities
Once you know what asset classes you’ll be in, you need to choose which specific assets you will purchase.
For “equities” (i.e., stocks) you might want to go with something like the iShares S&P/TSX Capped Composite Index Fund (TSX: XIC). The iShares S&P/TSX Capped Composite Index Fund is a highly diversified fund holding 220 stocks. It passively tracks the S&P/TSX Capped Composite Index, meaning that it incurs no active management costs. Owing to the lack of active management costs, the fund has very low fees: 0.05% management and 0.06% total. The fund is also highly liquid, with narrow bid-ask spreads – so you don’t lose much money to market makers when you trade it. Finally, XIC pays a small dividend yielding about 2%.
Step 4: Dollar cost average
Once you’ve decided on your environment, your asset allocation and your securities, all that’s left to do is invest progressively over time. Take, let’s say, 10% to 20% out of each paycheque, and put it into your securities portfolio. Over time, you should end up with a substantial portfolio capable of covering your expenses in retirement.
