May 19, 2022

JF2816: The Passive Income Mindset — How to Reduce Risk


In this episode, Travis argues that the “buy low, sell high” passive income investing strategy might not always be best suited for your needs. He introduces an alternative strategy to consider, using both real estate and stocks as examples.


The “Buy Low, Sell High” Strategy

“This is investing 101,” Travis says. “You put money in something and it goes up and you sell it.” This is the strategy that the Wall Street model is built upon — you invest all of your money, let it sit for decades, and hope that one day the value will be higher than it was before. 


The Passive Income Focus Strategy

This strategy, which Travis has been using for eight years, involves investing to receive streams of income. Like the “Buy Low, Sell High” strategy, both stock investors and real estate investors can use it. 


Cash Flow and Dividends

Travis uses stock dividends to illustrate the difference between the “Buy Low, Sell High” strategy and the passive income focus strategy. Say you invested in Netflix five years ago. Today, the stock is worth about the same as it was then. Since Netflix does not pay a dividend, you would have had nearly a 0% return and no cash flow in the meantime.

However, say you invested in AT&T 15 years ago. Like Netflix, its stock is worth about the same today as it was then. However, because AT&T pays a dividend yield of 5.81%, you would have received an annualized return of 5.81% of your original investment — receiving steady cash flow over the 15-year period despite the fact that the value of the stock barely increased.


Infinite Returns

When you receive annualized dividends and use that money to make additional investments, it creates even more cash flow. “Robert Kiyosaki has talked about this for years,” Travis explains. “When he puts money into an investment, his objective is to pull that money back out as soon as possible and then redeploy it into something else.” 

In terms of real estate, this is often done through refinancing on one property, cashing out, and investing in another property while still receiving cash flow from the first one. “This is the snowball effect,” Travis explains. “This is how effectively the rich get richer.”



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Travis Watts: Welcome, Best Ever listeners, to another episode of The Actively Passive Investing Show. I'm your host, Travis watts. Today's episode is titled The Passive Income Mindset and How to Reduce Risk. As you know by now, I am not a financial advisor, financial planner, I'm not telling you what to do; this is just for informational and educational purposes only on these episodes. But hey, listen, I'm always happy to share the way I see things in my perspective. Some of you resonate well with that, others do not, and it's totally cool. But if I can help people in reducing risk, or maybe realizing something they didn't otherwise realize, I'm all about it. That's what this episode is.

What we're talking about is passive income, as we do a lot on the show, but not just real estate, cash flow, and not just syndications and stuff, but just this concept of passive income investing. I want to paint the picture in a way I've never painted it before on this show or any other podcast, and I hope you find some value in it.

Since these episodes that I do are on YouTube and they're visual in that regard, I wanted to do some visuals in these episode, so I've grabbed a couple of charts and graphs I want to show. If you're tuning in on audio, no worries, I will do my best to articulate what I'm showing on the screen, and I'm sure it'll still make sense in concept.

Many times on this show I've brought up how most of us are raised with this “buy low and sell high” investing mentality; this is investing 101. If you've watched any kind of TV show about it, it's usually you put money in something and it goes up and you sell it. Whether it's venture capital or these shows like Shark Tank, or whether it's the house flipping shows on HGTV - a lot of us think of investing that way, especially in the beginning. The whole Wall Street model is built around it. It's just put all your money in Wall Street and let it sit there for decades upon decades, and hopefully, one day, it's higher than it was before.

In this episode and to that theme, I want to talk about the alternative strategy, the one that I've been using on a full-time basis for about eight years now. It's the passive income-focused strategy, it's investing for streams of income, versus “buy low and sell high”. Whether you're a stock investor or you're a real estate investor, it really doesn't make a difference in terms of what I'm going to share with you; this would be applicable to either -- so right before turning on the camera here, I just pulled up on my screen a couple of widely-known stocks. I only use these because they're the two that came to mind for me when I thought about a “buy low/sell high” kind of stock and a cash flow or dividend-paying stock. I'll relate this here in a bit to real estate for all you real estate folks. The first chart, by the way, as I'm pulling this up, is a chart that I pulled - I'm filming today on May 2nd, 2022, so the numbers I'm sure have changed if you're going to go research this after the episode. Some of this may be non-applicable as far as today's pricing and the yield and all this, but the philosophy still holds true.

What I've got here is I've got a five-year chart pulled up of Netflix. Netflix is a name, I think, most of us know. I wouldn't say it's a blue-chip company, because... We'll get to that in a minute. But it's a widely-known mega-company in its niche industry of streaming services. Here on this five-year chart, if you pull back here to December 29, 2017, Netflix was trading for about $192 per share. Today, as you can see, it's about $196 per share. Roughly the same valuation, give or take a few dollars here. The thing that I'm pointing out on this chart is Netflix does not pay a dividend. This is not a cash flow play in any way. Most people have the philosophy and the mindset in December 29, 2017 that, “Hey, this looks like a really nice growth opportunity. I'm going to park some capital here. I'm going to fast-forward five years and hopefully, my account’s bigger than it is today.”

As we follow the trend and we look at the story here of five years, you would have been exactly right... Less than - what, about six months down the road after investing; you've almost doubled your money, which is just incredible, it's kind of unheard of. Then we have a pullback in Netflix and it sinks down to almost the point where you bought in, and then another bounce-up, which feels real great, and then some more volatility and it falls back down, and then COVID hits. Netflix just skyrockets up, and everyone's jumping in on the bandwagon. It does incredibly well, and then here, this year, it falls down to the point where you first bought in five years ago. When you look at that scenario, you think, “Wow," in five years, you nearly had a 0% return and no cash flow in the meantime.

This, right here, is the point. This is why I don't invest with the “buy low and sell high” mentality, because you just never know what's coming down the road, you just don't know what stocks or what real estate is really going to outperform and do exceptionally well. I won't hash out the whole Lost Decade again. I know I've mentioned that probably too many times on the show. But it can just happen where you buy in and things go up, and then they come back down. The stock market is always prone to having pullbacks, recessions, flash crashes, and all the rest. It's a very volatile environment. In fact, it was funny - I was just reading the headlines of Warren Buffett and Charlie Munger at their Berkshire Hathaway meeting and they're bashing Wall Street for essentially turning the whole platform into a “gambling casino”, in their words. I just thought that was funny.

In any case, let's switch off of Netflix here and I want to pull up another chart for you. Alright, so up on the screen now I just pulled up AT&T, another company I'm sure a lot of us are aware of. Here, I've scrolled back actually all the way to 2006, back in February, so nearly 15 years ago, something like that. AT&T was trading for about $20.22 per share. Today, it's $19.10. Again, not the exact same, but pretty relative pricing within $1. At first glance, you look at a chart like that and you think, “Wow, what a crappy stock. This thing has just been trading flat for 15 years; it hadn't done anything.” Here's the catch. If you scroll down here on the chart and you look here at the dividend yield at the bottom. 5.81% - that's an annualized passive income, dividend, whatever you want to call it, distribution, yield. In fact, now that I'm looking at this, I swear this was like a 7% or 8% dividend just a couple of months ago. I think they just reduced their dividend, probably for the first time in a very long time. But in any case, let's still paint this example that I'm making in this episode using the current lower, conservative dividend yield.

This is the way that I invest. I'm not promoting or endorsing this particular stock. I'm just saying passive income and looking at yield like this. Here's my take on it. If you use the Rule of 72 - we've talked about that too a lot on the show. But if you're not familiar, it's just the simple concept of how long it takes you to double your money. The math is you take on a calculator, 72 divided by the annualized return that you anticipate receiving, and then equals how many years it takes to double your money. In this example, let's round up, because the dividend was 7% or 8%, now it's 5.8%. Let’s say it was about a 6% yield over the last 15 years or something; you take 72, divided by six, and that equals 12 years to essentially double your money just through the passive income.

The point is, if you had held AT&T with that kind of cash flow since 2006, you would have more than doubled your money just through passive income. The added bonus to investing for passive income is you could have done a multitude of things with those distributions. You could have reinvested back into the stock, and then had more cash flow, compounding, you could have taken those cash dividends and lived off of that income, you could have taken the cash dividends and reinvested in something else, which is what I tend to do to further diversify. In case, let's say AT&T stock goes to zero or goes bankrupt or something crazy, at least, I was taking the distributions and putting them somewhere else, perhaps into a real estate investment or something like that.

Break: [00:10:09.13] - [00:11:56.03]

Travis Watts: If we stop for a minute and we just think about this concept, if we put, I don't know, $100,000 into AT&T back then in 2006, and now we know that we've more than doubled our investment, we've received more than $100,000 in return in dividends and distributions... Well, we still hold AT&T today at approximately the same price that we paid back then. It continues pumping out about 5.8% annualized dividends, and we have that other money that was sent to us that we have now hopefully parked into more investments that are also producing more cash flow, or passive income. It's an infinite return of sorts in that regard. Robert Kiyosaki has talked about this for years. When he puts money into an investment, his objective is to pull that money back out as soon as possible and then redeploy it into something else.

In terms of real estate, which is what he generally promotes, that's usually done through, say, refinance. He invests in multifamily apartments, it goes up in value because they've increased the rents on the property, they do a refinance, they cash out and get their money back that they first put in the property, and then they go put it in something else, but they keep ownership over that apartment building. They continue receiving annualized, or I should say, monthly cash flow off of that property, and then they go redeploy the same original capital into more investments. This is the snowball effect, this is how effectively the rich get richer. Hopefully, that lands for you. Hopefully, that resonates. That's a pretty big concept to understand for a lot of folks.

Now, I do want to bring up a counter-argument that I'm sure some of you are thinking. You might say, “Well, you're not looking at the total return.” In other words, “What if you had invested in Netflix in 2006 at a very low basis and look at it today? You'd be up a bagillion percent.”

My answer to that is, “Well, that may be true in the case of Netflix, specifically. However, you would have also been speculating and not investing. Because as I'm sure you're aware, there were a lot of companies trying to get into the mail you DVDs to your house, or the streaming services that completely failed. They wanted to compete with Netflix, Netflix was the dominant force in the industry and they went bankrupt. You could have said the same about them and said, “Well, I could have bought XYZ company at $2 per share, but today, they're $0 per share.”

The main thing that makes that speculative is that it's not paying you any kind of dividend or cash flow that can be used as immediate income to do other things with. As each distribution is received, you're effectively lowering your risk, to the point of the title of this episode, How to Reduce Your Risk. Anything that's paying you monthly or quarterly is essentially sending you some of your capital back in a sense, and thus reducing the amount of capital at risk and whatever it is you've parked your money into.

Now, the same conversation could be had for real estate, because I've gotten some feedback that says, “You're so anti the stock market.” I'm totally not anti the stock market. I do hold publicly-traded equities, I do invest in stocks, anything that's going to pay a dividend, ideally on a monthly basis, some publicly-traded REITs, and stuff like that. But the point is, let's relate this to real estate, because that's not created equal; that's too much of a generalization. It's the same reason I quit flipping houses, because - I hear this all the time, “Why would I invest as a limited partner in a syndication, making, I don't know, 15% annualized returns on average over time when you factor cash flow and equity and stuff, when I could go flip a house and make 40% annualized?” And I say, well, again, that may be true in the case of a flip.

You may also lose money on the flip. You may not be able to use that strategy in downturns, for example. But also, there is an element of speculating. You have to assume, when you're flipping a home, you're buying below market, that the market is going to continue going up by the time that you sell, and that there are going to be buyers in the market willing to pay a higher price than what you paid; and you're having to estimate the cost of materials, and you're having to deal with all the labor shortages and supply chain issues that are going on... So yes, if you execute properly, if you buy right, if you get lucky, and the Fed doesn't bring interest rates up another 3% or 4%, then you can potentially make a higher return by doing that. But I still say it's more speculative than it is being an investor.

Like always, you guys, this is just simply my perspective in educational purposes only. I always say, “You do you.” If you want to gamble, if you want to speculate, if you want to be in these alternative asset classes of crypto and other things, by all means. I'm not saying don't do that stuff. I'm just saying this is a different way to look at it. You're reducing risk anytime that you're receiving distributions back because of passive income. I've certainly used “buy low/sell high” in the past. As I mentioned, I used to flip homes and do things like that, but anymore, I just tend to look at passive income investments. Because I prefer having the financial freedom and the ability to live on passive income, which frees up a lot of time, and takes a lot of pressure and stress off of my life, because I don't have to rely on an active income source when I have a multitude of diversified income sources coming in every month. So you do you. I’m not telling you what to do, I'm not a financial advisor. Please always seek licensed financial advice when it comes to making your own investment decisions.

A real quick story I want to share with you, one more real estate story is - I was very familiar with a development project. It was supposed to be about a 100-unit multifamily build-out years ago, and I knew a lot of investors that were going into this project. The firm putting the deal together, they were a bit naive, we’ll say, and they failed to realize a multitude of factors and how much costs were going to be involved between engineering and pulling permits and the whole construction phase of it. It's just a lot of moving parts. Long story short, this was a syndication offering where the investors ended up losing somewhere in the ballpark of about 30% of their capital, because they couldn't even get the project off the ground. Because again, you had to speculate and guess on a lot of factors that, unfortunately, this group kind of guessed wrong, we'll say.

On paper, those projections looked quite high and looked very nice, very stable. In my opinion, you should get a higher return for taking more risk like that. But unfortunately, that was the end result of that syndication, versus going into something that's already stabilized, already occupied, already producing positive cash flow on day one. You are, again, reducing your risk, because you already have something pumping out passive income. Again, each distribution that you receive is lowering, in a sense, your cost basis in the deal. So even if the firm or operator failed to really renovate units and move the business plan forward, hopefully, you would still be getting your monthly or your quarterly distribution. Just something to keep in mind, we're all different, and we all have different risk tolerance.

If you've found this episode helpful, that's awesome. If you didn't, well, feel free to just not listen to me or to find other Best Ever episodes that relate more to your goals in your philosophy; controversial topic, to say the least.

Thank you, guys, so much for tuning in to another episode of The Actively Passive Investing Show. I truly appreciate it here lately, a lot of people have been reaching out through LinkedIn to connect. Feel free to do that. I'm also on BiggerPockets, I'm also on Facebook, and I'm also on Instagram. However, you guys want to reach out, I'm happy to be a resource. The conversations have been awesome, the feedback has been awesome. You don't have to agree with everything I say, but I appreciate you guys pointing out the pros and the cons of how you see this content. Have a Best Ever week and we'll see you on the next episode of The Actively Passive Investing Show.

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