060: The Power of Portfolio Income to Unlock Financial Freedom

00:00 - 33:34 | Christopher Nelson: : Portfolio income is ultimately one of the keys to getting you to financial independence. However, many are undereducated when it comes to what are the options. And if we don't understand our options, then we may be pulling in an asset that is good for somebody else, but isn't ultimately good for us. This is why it's so important as investors, we focus on systematic education to understand what are the assets out there that can provide us income, the risk level that we want. And this is done when you're ultimately running your portfolio as a business. Welcome to Tech Equity and Money Talk, the only podcast that talks about building wealth with tech equity and how to manage the money that comes with it. Do you work for equity compensation? Do you have questions on how your tech equity and money work together? Welcome. Every week we discuss strategies and tactics for how to get smarter around equity compensation and money management to help you reach your financial and lifestyle goals. Let's get to the show. Hello and welcome to Tech Equity and Money Talk. I'm your host, Christopher Nelson, and today we're going to be covering one of my favorite subjects, which is portfolio income. Portfolio income is essential in your portfolio to getting to financial independence. It is the difference between an evergreen portfolio, a portfolio that can last for multiple generations, and a drain and pray portfolio, which is otherwise known as the 4% rule. And so today's episode, I want to educate you on what are different types of income investments out there that you can bring into your portfolio. I'm going to share with you some of my experience. This is something I'm a fan of is applied wisdom. I want you to hear from somebody that has been there, done that, has experience with these things so that you can understand how some of this works and where you may want to start exploring some of these vehicles yourself. Many of us want to get to financial independence. And financial independence is gained when you have portfolio income in the way that I advocate for. And again, I am not an investment advisor. I'm an educator who is sharing things that I have learned from managing my portfolio in a style that's adopted by DECA millionaires and above. And this is the 50-50 portfolio methodology. If you go to episode 39 of the podcast, I break down for you this 50-50 strategy. But a key element of that is having income bearing assets in your portfolio. And so today I want to cover up on the spectrum. Now, you may say, Christopher, I know all of those and That's great. But there's many of us in technology who haven't been exposed to these. And I think there's three main reasons why technology employees may not know the breadth of what's available to them out there. And I'd say it's for three main reasons. Number one is it's a little outside of our area. Many people who work in technology just understand and focus on venture capital to public company or venture capital to acquisition, which is a very specialized model in the investing world. And we all know that growth tech stocks have added more wealth to many people in the last 24 years than arguably many other things. However, it's not the universe, it's not the world, but I think many of us understand what's in there and need to be exposed to something that's broader than that. I also think that some people don't look outside because they're focused on what I call this high octane investments, meaning they're enamored with these multiples that they can get out of owning technology companies, whether that's venture capital investing or working for them. And so they don't stray outside of that area because they like the result that they see. And ultimately, I think the third reason is there's just not a lot of education. There's not. And so I want to solve that problem today by going wide, giving you a high level overview of what these assets are and looking at it from the lens of traditional investments, things that have the oversight of the SEC and in larger regulations, and then also the alternative and private investment area as well. There's one thing I want to talk about. I want to talk about the elephant in the room. The elephant in the room, and part of that has to come with a confession, right, is in the last few years, there have been many people talking a lot about passive income. And I have to say, I'm ultimately sick of that term. I'm sick of it. I am. Because ultimately it is a term that has now been overused, has been over leveraged. And I think it leads people to believe something that's not ultimately true, especially if you're on this road to financial independence and you're trying to build your portfolio as a business and leave it as a multi-generational asset. And so there's a couple of things I want to dissect here. First, I want to confess. I know that as I got into raising and creating funds and investments around private equity, I leveraged the term passive investing as well. And I have made a conscious choice to no longer do that. I'm calling it portfolio income because I want to remove the perception that this whole concept of passivity, meaning I think people interpret this as it's on cruise control, it's on automatic, it's false. When you're investing in private equity, you need to be engaged. Now, is that a 40-hour a week job? No, it's not. But it is something that is regular, that is systematic, that if you want to improve as an investor, you have to keep your eye on the ball. And it's not, I'm going to check on this thing once a year. It's definitely not that. So I'm moving away from it because I believe passive is being used as something that is not what it's meant to be. And also it's just not the correct use of the term. Passive income in the way that I view it as an investor is truly a tax term. It's a label that I want specific income labeled by the United States IRS, the internal revenue service that I can then apply depreciation into, and I can get income out of my portfolio more tax efficient. When I think ultimately about the goal. of financial independence, what we really want is portfolio income. We want our portfolio to produce income for us, and it's going to come in a lot of different flavors. And the more we learn about it, the more as I am managing my portfolio year over year, month over month, now being outside of full-time W-2 employment, I now am really focused on how do I optimize all areas of my portfolio for income and continue to grow different areas that I may not have done previously. So I will use the term portfolio income going forward. And the context that I'm going to set this up in is in episode 39, I talked about my portfolio strategy where there are growth assets and income bearing assets. Growth assets are assets whose job in the portfolio is to increase in value. That's their only job. And you can think about growth stocks. There's also different private equity investments where there's no expectation of cashflow. The job is just to expand in size. And at some point there will be a liquidity event, or you can sell them when it comes to a stock, let's say, and you can get liquidity. I'm not going to be talking about those today, growth assets. I'm going to be focused primarily on the income bearing assets and income generating assets. Part of how the asset is created is to have a steady stream of income that can be paid monthly, quarterly, or annually, depending on the investment. And this comes through a dividend, some type of cashflow that's coming off of the instrument. It can be coming, you know, you're receiving interest, or it can be from profit that then comes in the term of cashflow coming from the asset as well. And so when we think about this in the 50-50 portfolio, the goal that I have set up is to have 50% of my capital under management in income producing assets with the blended goal to return 10% cash on cash a year. And I have that goal because I think it makes the math easy. Then you understand if you have a $4 million portfolio, the target is $2 million in income producing asset with $200,000 of income being produced a year. And the ultimate goal is that to be very tax efficient. So I'm paying less tax than wage. And so with that, the goal, I want to now talk about what are the types of assets. This is where I want to spend the majority of time today is what are the type of assets that I am looking at to invest in that's going to help me meet that goal. And then I'm also going to talk about where I do have current investments that provide those. Before I get in there, let's remember a couple of foundational principles as we're thinking about this because I'm going to highlight some different assets and keep in mind that when you're managing your portfolio as a business, you concretely realize that wealth is created through concentrated, it's managed and grown Through diversification. So thinking about a broad number of assets that we can strategically diversify into for different results is really important. It's also where we're understanding the breadth of these assets is important as well, because you want non-correlated assets. If everything is tied to the stock market and the stock market is going down, that means your portfolio is going down. I was able to understand going into 2020, having a large private equity portfolio, having a large stock portfolio split. As I saw the stock portfolio go down, I saw values in in the real estate go up, I saw some returns head north in that direction. And so that helped me understand, wow, when you have a broadly diversified portfolio across non-correlated assets, that then helps you build this financial fortress for your family that can weather a lot of different storms. And then like anything else in investing, finding core strategies and being consistent in the way that you invest and to continue to de-risk and find strategies that are simple and boring, but create money and income for you are essential. So, keeping that in mind, I want to now talk about traditional assets that would be income bearing. So, if you want to understand alternative assets versus traditional assets, I have episode 20 where I break down alternative investing, where I break this down, and I'll give you a quick high-level overview. are investments that are overseen by the security and exchange commissions. So what's considered traditional investments are going to be your high yield savings account, certificates of deposit, stocks, bonds, and REITs as well that are being traded on public markets. All of those, and even some annuities that are treated as financial instruments, all of those have very intense reporting requirements that they need to provide to the SEC. And that then means that they are able to be traded on public markets, which gives them the benefit of liquidity. So out of those traditional assets, what are some that are the do traditionally create income that we should look at and have in our portfolio? Well, number one, the easiest and very secure is a high yield savings account. And right now, high yield savings accounts are producing 5%. And so cash right now is able to produce 5%, which is a very high yield from the last number of years. But if you go back into the eighties and nineties, there were high yield savings accounts that were at the same five, six, even I believe there was a point when it was at 7%. Associated with high yield savings accounts that are very liquid, you also have right next to them certificates of deposit where you should be getting additional points. And now it's in and around 5% with maybe some 5.15, 5.25, some additional BPS that you can get, some BIPs that you can get by locking it up for a specific period of time, six months, one month, two years, et cetera. Then you have the other traditional asset known for income are bonds, and you have a wide spectrum of bond instruments that you can invest in. There's everything from US government bonds to bonds that are being traded on the stock market. high-yield corporate bonds, you have tax-free municipal bonds that you aren't paying any tax. And when you look across that spectrum, it's an interesting place where you can deploy capital and be getting a return on your dollars and looking at some of these tax-free municipal bonds versus high-yield savings bonds when you think about the fact that you will have to pay taxes on that income. It's not treated the same way as real estate income, passive income, that looking at tax-free versus higher interest points are valid options. There's also real estate investment trusts. So these are where companies like BlackRock and Apollo have very large holdings that then they roll up into these collection of real estate assets that are treated as funds that you can then invest in and they do provide a dividend. There's also dividend bearing stocks and all of these. You know, bonds, dividend bearing stocks and real estate investment trusts or REITs all also have ETS exchange traded funds that can provide additional diversification, meaning, and you can start looking at a blended return from those. All of those are viable options to put inside of your portfolio that can continue to generate income. And again, when you're thinking from a tops down perspective of how do you diversify and manage your assets, it's important to think of some of these options because they provide very specific benefits. The other one that's come to light recently, I'm doing a lot of research on is options trading. Options trading in my research has shown that options used to just be on monthly contracts up until around the year 2000 as technology advanced and they could start trading You know, these, the ability to buy and sell options against stocks as the technology increased. Now there's strategies, very conservative strategies. There's aggressive strategies that you can use against a portfolio that you own, or you can also do it against margin to generate income. And I am getting to know, I'm now networking in and getting to know people who are leveraging this as a strategy to bring in income as they're managing their portfolio full-time as a business. And like everything else, you need to understand risk, you need to study and learn the actual techniques, but it truly is a viable option. All of these fit under this traditional umbrella of investing and can provide different levels of income to your portfolio. And for you as your portfolio manager, it's important to then look over your portfolio and ask what portions work for you versus the risk that you want to take. Some of these are very viable options. I know myself, I have some dividend bearing ETFs. I also have some holdings in some tax-free municipal bonds. And then I also leverage high-yield savings accounts across running my businesses and then my portfolio as a business. I make sure all my cash is in a high-yield savings account. Even in business savings accounts now, there are some that provide large 5% interest, which is amazing. And so the important thing to understand is that people choose this. I choose these assets because of the fact that they are conservative. High-yield savings account has the FDIC insuring the deposits. The stock market, the bond market provides some liquidity so that I can take it out. There's also with larger dividend bearing stocks, there is predictable dividends that come in quarterly. And it does, as you set that up, that is less management intensive for me, the way that I have it structured than my private equity portfolio. Now that could change as I'm looking at managing option strategies. I could then have to bring in and have more management because that's something that you need to be actively managing and engaged in there. But these are all trade-offs. And these are not to be disparaged, but they are to be looked at and understood as you're managing your portfolio to understand what place may they play in your portfolio. Because as you start managing a portfolio that gets larger and larger, you want to have areas that are meeting certain performance criterias that takes less of your time. You want to be strategic in that because you want to spend the majority of your time in your portfolio. where there's more risk and it needs to be more actively managed. That is critical. So those are traditional investments. And I may not have covered all of them. I know that I am continuing to uncover more and more, but that right there is the basics. Those are the fundamentals. Now let's pivot and let's talk about private equity. Private equity adhere to specific rules of the SEC, the Security and Exchange Commissions to operate outside of it. And so outside of the SEC and outside of traditional investments, you're going to find a much larger universe. If you want, again, more of a breakdown on private equity, I would refer you to episode 20 of Tech Equity and Money Talk, where I provide an overview of alternative investment. but I'm going to go deep today on some more of those just so that you understand. So I would say the most well-known in private equity, especially today, is private equity real estate. And when I say private equity, I guess there's, there's two ways to think about it in alternative investments. There's in your portfolio, you can have direct holdings, real estate that you own outside of your primary residence. And then there's also investments that you can make inside of private equity syndications and funds that allow you to hold real estate. A lot of people talk about real estate as a core investment in a way to build wealth. And the reason is, It is a multidimensional asset. I want you to hear that again. Real estate is a multidimensional asset that you can generate four different ways to make money off of real estate. Number one is the cashflow. When you buy an asset at the right price and you have profit over the expenses, income over the expenses that generates profit, that is then your cashflow. Number two, you have appreciation. Not sure I could say that. That's the value of the asset increasing over time. You also, depending on the loan structure, have equity pay down that if that is included into the cost of your rent, which it is for majority of people, then you're owning more of the asset over time. And then the fourth, the magical one is depreciation. Depreciation is this loss that you can carry as a balance over time on your taxes that allow you to then pay less taxes when it comes to the income. It's because of those four things in real estate, cashflow, appreciation, equity pay down and depreciation. Those four are the magic things that allow you to make this money in multiple different ways with real estate. That's why it's so valuable. That's why people love it. So in your portfolio, you can have direct held real estate. I know that in our family, we have a portfolio of some single family homes that we purchased after the sale of our property in the Bay Area upon moving here to Austin. We leverage those homes to cover all of our housing expenses. This is when we started to realize how income can be so powerful because the steady income all of a sudden starts reducing our expense line. You can also invest in real estate in syndications. Syndications are where multiple investors and usually two shares of partners, there's general partners who are the operators who run the asset, limited partners who come in with limited liability, they come to own a single asset And that is called a syndication. You're creating a syndication to own an asset. The same thing can happen in funds so that you can own a lot of like kind assets in a single fund that behave in a very particular way. And this is where you need to be specific on the syndication in the fund. There are income focused and there's others that are growth focused. And there's some that are hybrid. So understanding clearly what's important for your portfolio and also what are the real estate assets being placed in there is really important. Many people understand and know multifamily or apartment buildings, and it's become increasingly popular over the last few years, placed in syndications or in funds. The reality is As prices started to increase in 2019 through 2023, I think it was the last year before interest rates shot up, I saw some trading at the beginning of the year, is a lot of the cashflow wasn't there. Prices appreciated so much for them to trade, they became more growth assets than they did income. It was really in other real estate classes, industrial, self-storage, mobile home parks, RV, even marinas. There was more cashflow in some of these assets that could be purchased at lower prices or had lower operating margins that provided the cashflow in real estate. Real estate is a core income bearing asset. It just needs to be purchased at the right price. And it's so important that when you are making these investments, you understand how to underwrite and vet the assumptions so that you can understand this more. And in subsequent weeks, I'm going to be introducing some different asset classes and doing some deep dives on them so that you can understand them as well. And one of my favorites, mobile home parks, I'll be doing another solo episode on to give you a deep dive into that. And so private equity real estate investing can be done through syndications, can be done through funds and done for cashflow. And it's so important that you look for income focused funds. There's also, and that's on the, what's called the equity side of the investment, meaning that you're owning part of the asset. There's also ways that you can invest in real estate on the debt side. And that's become popular, I'd say in the last 12 to 18 months, you'll see a lot of debt and credit funds open up where you're buying different portions of the capital stack. Understanding the capital stack is so important, understanding what the difference between senior debt, mezzanine debt, preferred equity. And the reality is, is It's so important to understand because the further down you are in the capital stack, meaning senior debt is going to get paid first before equity. Equity is usually the last and the highest risk on the capital stack, meaning that debt funds are a great way to generate income, reduce risk. And again, not all operators are the same. Not all funds are the same. You need to do your due diligence. This is not advice, but it's a great way to produce nine, 10, 12% cash on cash return. The key thing to understand is because you don't have equity, there's not going to be depreciation. So they can be high cashflow, but not as much depreciation. And so that's really the real estate umbrella when it comes to private equity is you have the different vehicles, whether that's you can buy that yourself, personal real estate holdings, what's called active real estate. Then you can have more of the passive real estate, meaning that you're not an operator in the form of syndications or in the form of funds, or you can actually invest on the debt side. Outside of real estate, inside of private equity, there are many, many options and things that you can purchase. I have seen royalty funds where you get the opportunity to be a limited partner owning royalties of specific music. The royalty funds did very, very well in 2020 in the COVID environment when people at home and they were listening to a lot of music and those funds shot through the roof. There's also litigation funds where you're investing in a pool of money that is providing dollars to lawyers to go litigate. And then if they win money, then you get a return on that. There's also life insurance funds where people want to cash out life insurance, get money now. So then they're taking less money. You're then getting When they pass away, then there is a larger investment coming back. And there's so many. One of the things they have now in private equity funds is you get the ability to own different parts of the businesses and different capital stacks. So this is private equity. You think of the larger Vista Equity, Tomo Bravo. They have investors. They have a lot of institutional investors. There are mid-sized private equity shops owning businesses that take limited partner capital. as well, that you get the opportunity to participate in businesses. And again, depending on how those funds are set up, it could be cashflow. There could also be depreciation as well, depending on what type of assets they own. So there's a giant world. And I think for myself, so what have I invested in from a private equity perspective? single-family homes, multifamily, self-storage, mobile home parks, industrial buildings, farmland, invested in some farms, and also private businesses, and invested in quick service restaurants, so Burger Kings and Subways, also invested on the debt side, have some exposure to some debt funds as well. And it's the whole of that that is then generating Income it with between that and then and then the income that I'm getting off of the traditional side as well. All of that combined is Replacing the paycheck. And so why do people choose private equity investments, right? I want to talk a little bit right, you know, we looked at for traditional investments conservative their liquidity Less management intensive and there is a level of predictability you think about interest coming from your checking account that's coming monthly It's very very predictable On the private equity side, there's an opportunity to be conservative on the private equity side as well too. If you buy assets very low, if their newer assets don't have a lot of maintenance, those are conservative assets that can just generate some really steady returns monthly as well. They're also non-correlated. So you're building out this portfolio that's non-correlated to the market. You can also get higher income, right? When you're talking about debt funds, you're talking about mobile home parks, you're talking about self-storage. And again, this all depends on where the operators are buying. What are the relationships they have? Cause you make your money when you buy, you establish your cashflow when you buy. And so you can make higher rates of income in private equity. You can also find what's called asymmetric returns. The reality is there are these private businesses that have been operating for years that have a clear competitive edge because of their exposure to the marketplace, their exposure to deal flow, the efficiencies that they have in their business, that they're able to just continue to make money. This is one of the things I talk about in episode 20 is that private equity has been private, meaning that we weren't allowed to talk about it online more than it has to present. We started hearing more about private equity in 2012, starting from 2012. So this means there's a lot of operators and deal flow that many of us, including myself, don't have access to that's filled up by family office money and ultra high net worth individuals. The reason being is that these people are running these very boring businesses that have really nice cashflow that just continue to work like clockwork. The opportunity is to find, engage with them and understand are there opportunities to bring retail, meaning our personal capital to these types of investments. So asymmetric returns. The other one is illiquidity, right? They're illiquid assets, but this is also where people like to have capital tied up so that they're not letting it bleed into their lifestyle, right? And that they're actually having it work for them. So there are strategies that say, I want a portion of my portfolio illiquid, not having access to it. I want a portion of my portfolio that is very liquid that I can access very, very quickly. This all comes down to when you're running your portfolio as a business, having a thesis, having a management structure so that you can throttle that appropriately with what you need and what meets your goals and your criteria. Ultimately, the strategy with all of these income assets that I've shared with you today is to align them with your goals. Where do you want to be conservative? Where do you want to have more risk? Where do you want to spend time managing it more aggressively to drive the result of your portfolio? Your portfolio can be a multi-generational asset when you make the decision to be the CEO and drive it. And when you do, you have to design it in a way around you and where your preferences are. Do you want to be focused on getting a lot of income from private equity and spending your time partnering with operators and understanding where you're going to be deploying capital in the next two to three years? as capital is being recycled and coming back to you? Or do you want some income on automatic and you actually want to develop skills in options trading and you actually want to generate your income that way? There's no one size fits all. You can ultimately do a blend of both, but focus on a set of assets that you want to get to understand first, that you want to deploy capital to. Also understand what are the more conservative assets that you can get your money working at right away. Because the more you understand how this works, the more that you understand how to create a portfolio to meet your specific objectives for you and your family, the faster you're going to be able to accelerate to financial independence. And if you're strategically leveraging your time and talent and thinking like an investor, and you're pulling out multiple paychecks a year, multiples of your paycheck that you can fuel this thing with, You're going to get there faster than you realized. So I want to say thank you so much for joining me today. I hope you enjoyed that. In the subsequent weeks, I'm going to be covering off on interviewing a multifamily operator, talking about the state of multifamily and where there's opportunities going forward. I still believe wholeheartedly in that asset class. I'm going to be doing a solo episode on mobile home parks so that you can understand the value of that asset class and keep your eyes peeled for what opportunities are coming up there. And then also debt funds. I'm going to be talking with a debt fund operator to understand where's the risk, how do you qualify, how do you look at good debt funds? Because ultimately, I want you to be able to take control of your future, to be able to work strategically for equity, Accelerate your road to financial independence and then become an experienced portfolio operator and pass that on to the next generation. Hope you enjoyed this episode. I'm Christopher Nelson.