This is post in a continuation a recent article called Why Invest Money ? Part 1.
The traditional way to save money was to put your money in a bank account. This bank account will then pay you interest on the balance of the account calculated over usually over a calendar month. This interest rate is very small as interest rates are at historic lows right now. Also, the interest received is taxed at marginal rate. Therefore, when saving money in a bank account right now, an individual is actually losing money because of inflation. Having a bit of savings is important though, such as for an emergency fund. Savings can be used to help pay for a down payment on a house or wedding for example.
I invest money in companies that pay me to own them. I am mostly invested in corporations and REITs at the money. These companies pay me once a month or once a quarter. This money in the form of dividends or distributions is more tax efficient than interest from a bank. When a company makes more money they often reward their shareholders with increased payouts. The increase in payouts is, in most cases, greater than the rate of inflation.
Yield on Cost (YoC) = annual dividend rate / purchase price
Current Yield = annual dividend rate / current price
Example : If stock ABC pays a annual dividend of $1.00 per share and I paid $20.00 per share, then
yield on cost is 5%. In 5 months time, the price of the stock goes to $25.00, then the current yield is 4%. If company ABC raises the dividend by $0.05 to $1.05 per share, YOC increases to 5.25% meaning your initial investment is working harder for you.
The interest rate on a savings account will not have increases that are greater than the rate of inflation.
With the dividends and distributions being more tax efficient, that means I get to keep more of my money. As the amounts of dividends and distributions I receive on an annual basis increases, I am able to have more options. This money can be used to enjoy a better lifestyle, to save for retirement of financial independence at a quicker rate, or to leave a job if it is not a good fit for me.
If a person is living paycheck to paycheck, they have to keep working there to they are able to find a different job. The job they hate currently have a negative effect on their mood which can have negative effects in a interview setting.
Increasing passive income allows a person to have more options. They are able to sleep better as they are less stress. Financial independence is when there is enough passive income to exceed expenses. When this occurs, an individual can CHOOSE to do what they want with their time.