As investors we are always looking for opportunities that will give us the best return for our investment. Most articles you read will be covering some great new opportunity that promises to make you rich but today I want to cover some of the passive income options that you should avoid. In these categories of passive income you may still find profitable ventures but they will be far fewer and in some cases may actually be a detriment to your investment portfolio.
The first topic is peer to peer lending (P2P lending). As the name suggests this is lending between individuals that are of similar status. A number of different companies and websites can be used to match lenders and borrowers. This lending bypasses the banks so lenders can offer loans to individuals at lower rates or to borrowers that were rejected by the banks. You can probably already see my issue with this source of income. Your working with individuals that the banks had reason to refuse service or your giving loans at a dangerously low rate. Either way you’re taking on more risk than the bank without the pricey lawyers a bank can afford. The P2P lending leaders claim you can make 5-7% per year. This used to be higher when P2P was relatively new but the returns have fallen as more capital has joined the market and more regulations have been created for the industry. The main issue with this investing is simply that some borrowers don’t pay back their loan and you would likely wipe out your profits taking them to court to get back your principal.
The next topic is private equity investing. This investing method is when an investor(s) offer capital in exchange for a portion of a private company. This can be in the form of investing directly into the private company or by investing in a fund that then invests in the companies for you. Generally this form of investment is limited to accredited investors meaning those with $250K income per individual or $1 million net worth excluding primary residence. Most funds will also require a substantial investment of at least $100k. The bright side of these funds are returns can range from 8-15% and they require little input from the investor. The down side is you will generally be locked in for 3 to 10 years and you have little control of the investment. When investing in a private company directly I can’t really say what return you will get. It all depends on the performance of the company. Everyone dreams of investing in the next google or microsoft but the sad truth is most of these new companies won’t survive long enough to pay you back. About 20% of startups fail in the first year and by the tenth year 70% have failed. As an individual investor your returns depend on your agreement with the company. Even if they do survive you may not see any return at all for years. To get anything out of the deal they either have to pay a dividend or you have to find someone willing to buy the shares. For individuals that don’t have the income to be accredited you can look to crowdfunding platforms but they still pose the same risk of failure. I’m not saying you should avoid private companies entirely but I would recommend thorough research of the company, their market, and their management before taking the risk.
The last topic for today are certificates of deposit and money market accounts. These are often considered safe investments because they will always give you a small return and most will be insured by the FDIC in the event the bank can’t pay you for some reason. The main issue is the low returns. Today it is difficult to find a CD that pays more than 2% and the best I have seen for money market accounts is 0.5%. The rate of inflation generally averages a bit over 2%. Remember the value of your investment is in the buying power of the currency you give up not the numbers written on the notes. With a CD you will be lucky to break even on the buying power of your invested capital and on a money market account you have lost 1.5% each year.
This concludes my short list of investments to be avoided for today. I’m sure I’ll have to add to this list as I learn more but I hope for now this helps you avoid some costly investments. For more tips on investing particularly in real estate check out the blog tab on www.leechandler.net
Marcus A Baker