Passive power

Opinion

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This article was published 21/09/2024 (389 days ago), so information in it may no longer be current.

If you’ve ever had the misfortune to attend a real estate seminar where a clean-cut, 20-something extols the virtues of ‘a can’t miss opportunity for bold investors like yourself,’ this plucky acolyte of free enterprise has probably praised the power of passive income.

Often couched as a secret of the ultra-wealthy, passive income involves ownership of an asset — i.e., real estate — that produces income (rent). Additionally, as a property’s increase in value, upon sale, it may also produce a windfall of passive income.

While true, it’s a little misleading — like a food recipe on TikTok. Slick editing makes it look easy but, in reality, it requires more work and skill than anticipated.

Easier ways exist to earn passive income from investing than leveraging yourself to the hilt, buying a rental property and collecting income.

That’s not to say purchasing real estate is not a worthy endeavour. But passive income/investing, it’s not.

“Being a real estate investor is not about doing no work and watching the money pour in,” says Dan Bortolotti, portfolio manager with PWL Capital in Toronto.

“I have clients who have done it, some of them very successfully, but most of them will tell you that it’s not for everybody and it’s not passive.”

Properties need emergency repairs. Renters skip out in the middle of the night. Property taxes, utilities and mortgages still must be paid.

Bortolotti isn’t a real estate investor, but he does know something about the art of passive investing for income and for growth. He’s the guy behind one of the nation’s most popular personal finance blogs: Canadian Couch Potato.

It advocates do-it-yourself investors build portfolios of passive, index-tracking exchange-traded funds (ETFs) that charge very low annual fees (management expense ratios, or MERs for short).

The notion here is that active strategies — selecting stocks, bonds and real estate — that aim to outperform the broad market is easier said than done and virtually impossible to do year in, year out.

Particularly after fees, mutual funds and other actively managed strategies are hard-pressed to beat their benchmark, like the S&P TSX Composite Index, year after year.

So why not pay a tenth of the price and just own the TSX, for example?

That’s what passive investing does, and it’s widely practiced by professional investors, including large pension funds.

“The stock market is generally very efficient,” Bortolotti says. It’s very hard for any investor to consistently find mispriced assets and beat the collective trading of all investors in the market, especially after fees, he adds.

So passive investing calls for building a diversified portfolio of stocks and bonds across many industries and geographies, constructed according to an investor’s goals and appetite for risk.

Today, you can even invest in all-in-one solutions offering low-cost passive investment solutions, like robo-advisors that rebalance your asset mix automatically to, for example, 50 per cent bonds and 50 per cent stocks.

Do-it-yourselfer can through online discount brokerage accounts buy all-in-one ETFs like the Vanguard Balanced ETF (VBAL) portfolio — with a 0.22 per cent MER — that gives them a split of 19,000 bonds and more than 13,500 stocks from around the world. The iShares Core Balanced ETF (XBAL) offers the same deal. The choices are many in the industry today that increasingly recognizes investors want low fee costs, diversification and simplicity.

As for real estate, the best way for investors to get that passive income is through real estate investment trusts (REITs). They are similar to ETFs, only they invest in commercial real estate — from office towers to shopping malls to seniors residences and multifamily rental to data centres.

“With REITs, you don’t have the headaches of owning property directly,” says Corrado Russo, head of globe securities at Hazelview Investments, which runs ETFs and mutual funds that invest in REITs around the world.

The average dividend from REITs is about four per cent, but they offer investors upside at this point in the market. Their values have been depressed because of higher interest rates. “There is a perception that higher rates mean higher costs for mortgages on properties,” says Russo.

That’s true, he adds, but REITs have also suffered because bonds, high-interest savings accounts (HISAs) and GICs (guaranteed investment certificates) now pay similar interest with less risk.

That is changing with rates seeming to be on a downward slope.

If that continues, more investor capital will flow to REITs seeking their higher yields. In turn, that will boost their share prices. At the same time, most REITs should be able to maintain and even increase payouts to investors as costs fall and rents gradually rise, Russo says.

All investors have to do is buy shares, hold them and collect the dividends.

That’s about as passive as it gets.

That is, except for investing in HISAs and GICs.

Ratehub.ca recently published a report on how post-secondary students can use these accounts to generate passive income and it’s nothing to sneeze at, given they still pay about four per cent.

“What we mean by passive income for students is a way for them to earn money without diverting their attention away from school or whatever else they have on their schedule,” says Natasha Macmillan, director of everyday banking at Ratehub.ca.

Be it a GIC, REIT or ETF, all of them offer you a way to build wealth — letting your capital breed more capital — without lifting a finger.

That’s passive power indeed.

Joel Schlesinger is a Winnipeg-based freelance journalist.

joelschles@gmail.com