June 15, 2023

JF3206: The 8% Rule — How to Simplify Passive Investing | Passive Investor Tips ft. Travis Watts



Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.

In this episode, Travis discusses his strategy for managing a portfolio of investments: the 8% rule. This is similar to the 4% rule many people live by who invest in the stock market, which says that when you reach retirement or financial independence, you sell off 4% of your portfolio each year and live off of that income.

The 8% rule is similar, except you are living off of the income your portfolio generates rather than having to sell off pieces of it. Travis shares how he’s used this rule for the past eight years.

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Travis Watts: Welcome back, Best Ever listeners, to another episode of Passive Investor Tips. I'm your host, Travis Watts. In today's episode we're talking about the 8% rule, how to simplify passive investing. Disclaimers as always, never financial advice; not telling you or anyone else what to do with your money. Please always seek licensed financial advice and do your proper due diligence when it comes to your own investing.

With that top of mind, the 8% rule. This episode is going to be short, sweet right to the point. Years ago, when I made a transition to being a full-time passive income investor, I was seeking a way to simplify the path to financial independence. I was trying to figure out how I was going to strategize managing a portfolio of investments. So this is where I came up with the 8% rule. It's loosely based on the 4% rule, which is a common strategy that a lot of people use in the stock market. The problem is the stock market is primarily equity-focused. It's all about buy low and sell high. So the 4% rule that's been around for decades and decades suggests that when you retire or reach financial independence, whatever you want to call it, you sell off 4% of your total portfolio value each year, and you live on that income.

So if you were to have a portfolio of stocks worth $2 million, and you sold 4% a year, you would effectively have $80,000 in income for that year, in addition to Social Security, or pensions, or any other forms of income that you might have.

So where the 8% rule differs from the 4% rule is that it's focused on passive income yield, not on selling anything. So if you had a portfolio of passive income investments valued around $2 million, and they were averaging about an 8% annualized yield, you would have 160,000 per year in income to live on. But you wouldn't necessarily be counting on any equity upside or appreciation in those investments. But with this said, many of you know I'm a big real estate investor, and there is often equity upside in the deals that I invest in. So when equity happens, when a deal sells and there's some capital gains, I use that as the icing on the cake. I use those gains to pay for any tax obligations that I may have at that point, or to cover any miscellaneous or unexpected expenses that may have popped up. And whatever gains are left after that, I simply reinvest them.

Break: [00:04:41.29]

Travis Watts: There's a few things I really like about the 8% Rule. Number one is I don't have to sell the golden goose. In other words, if I had $2 million in investments, I don't have to sell off against my net worth to generate income. I'm simply living on income that my investments are producing. Number two, I do try to invest in primarily value-add deals that have potential equity upside, and again, if and when that occurs, it's the icing on the cake that helps cover taxes and any other unexpected expenses along the way.

Number three, nearly every investment that I make, I try to hold on to it for longer than one year, so that any potential gains I have on the backend convert into long-term capital gains, which can be tax-favored.

And number four, generally speaking, if you are investing in real estate, the passive income yield might be higher than what you could otherwise achieve in fixed income instruments or from stock dividends. Of course, that's not always the case. I'm generalizing. But the deals that I used to do on my own in the single family space that were long-term rentals would usually have double-digit cash flow yield to them. And the deals that I do today, primarily in real estate private placements or syndications, the yield is ticking up year over year, as we're able to increase the rents and revenue on the properties.

And some fair warnings before I sign off on this short episode. Number one, there's always risk in investing; nothing is a promise or a guarantee. Passive income can be paused or reduced at any time, and not every deal you invest in is likely going to be a home run or exceed expectations. But with all of that in mind, I've been using the 8% rule for the last eight years, through the pandemic, through the rising interest rate environment, and it continues to work for me. But please remember to always do proper due diligence for you.

Something to think about here for the week. I hope this short episode was helpful to you. You're listening to Passive Investor Tips. I'm Travis Watts. Have a Best Ever week. Reach out anytime if I can be a resource or mentor for you. We'll see you in the next episode.

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