Alternative Income Ideas: Diversifying Beyond Traditional Passive Income Investments
Rethinking Passive Income
A few months ago, a prospective client came to me, visibly frustrated. His income portfolio was steadily losing value, and he was at his wit's end trying to figure out why. When I analyzed his investments, I wasn’t surprised.
His portfolio was filled with what I often see: high-yielding assets like dividend-paying stocks, REITs, closed-end funds, and corporate credit bonds.
The low interest rate environment that started in 2009 has forced income investors to make some pretty terrible tradeoffs in search of high-yielding investments.
The big issue? The income generated from these high-yield investments is typically unsustainable. His portfolio was paying out over 10% annually, but its total return (income + change in value) was just 5%, meaning the principal value of the investments was decreasing by more than the income generated. Thus, by living off the income without reinvesting, the principal was slowly being eroded, leading to lower distributions over time. I’ve seen this repeatedly over my career.
A lot of passive income investors build portfolios similar to what I described above. Then you have the real-estate rental enthusiasts—disciples of Grant Cardone—who believe real estate is the ultimate investment, often dismissing anything else.
And look, if real estate investing is your thing, awesome. It can be a fantastic investment. But be honest with yourself: It’s not a free lunch. Real estate investing comes with considerable trade-offs and risks, something many of its adherents are loath to admit.
Now, let’s pick on my tribe for a second, the financial advisory community, where one often-touted solution for passive income is private credit, an asset class I’m generally skeptical of.
While I’m open to the argument that private credit might have its place, I find that it’s susceptible to the same risks as most passive income strategies: economic cycle risk, interest rate risk, or both.
That’s why I encourage clients to explore lesser-known income strategies. These alternative approaches to passive income offer not only attractive yields but also diversification and resilience. In this article, I’ll introduce two categories of alternative income strategies: Collateralized Income Strategies and Dynamic Income Strategies.
Collateralized Income Strategies: Income with a Safety Net
Collateralized Income Strategies focus on investments backed by strong, tangible assets or legally enforceable claims. This collateral serves as a safety net, offering a layer of protection against losses. These strategies aim to deliver consistent income while minimizing downside risk, making them attractive for investors seeking stable cash flows and capital preservation.
Hard Money Loans
Hard money loans are short-term, privately negotiated bridge loans secured by real estate, such as multi-family housing or office buildings. Investors find these appealing because they offer high returns with the security of collateral. For example, a hard money loan on a commercial property might yield 8-12% annually, providing steady income backed by tangible assets.
Tax Liens
Investing in tax liens means purchasing the right to collect unpaid property taxes, often with double-digit interest rates. If the homeowner fails to pay, the investor can foreclose on the property. This strategy offers the dual appeal of income generation and asset acquisition.
Litigation Finance
Litigation finance involves lending money to law firms or individuals, secured by expected legal settlements. This asset class is unique because its returns are uncorrelated with traditional markets, making it a solid addition for diversification. For instance, a loan backed by a multi-million-dollar lawsuit payout could yield 10-15%.
Catastrophe Bonds
Catastrophe bonds (or “cat bonds”) are issued by insurers to transfer disaster risk to investors. They offer high yields, often in the range of 7-10%, as long as specified catastrophic events (like hurricanes) do not occur. For income investors seeking non-correlated returns, cat bonds are an intriguing option.
Specialty Finance
Specialty finance involves providing credit facilities to other lenders, secured by diversified pools of loans. These investments often yield between 8-12%, offering stable income with relatively lower risk due to diversification.
Life Settlements
In life settlements, investors purchase life insurance policies from individuals, becoming the beneficiary. The appeal lies in the fixed return upon the policyholder's passing. Returns typically range between 8-14%, depending on the insured’s life expectancy.
Royalties
Royalties offer a way to earn income from future cash flows in industries like music or commodities. For example, purchasing a slice of oil and gas royalties could yield a steady stream of income tied to production levels.
Dynamic Income Strategies: Flexibility and Adaptability for Market Returns
Dynamic Income Strategies leverage financial markets to generate income through active trading and strategic positioning. These strategies are designed to adapt to changing market conditions, providing income while offering liquidity and diversification benefits. They capitalize on market inefficiencies and trends, making them ideal for investors seeking flexible and innovative approaches to income generation.
Options Selling
Options selling involves generating income by selling short-term call and put spreads on various securities. With potential yields exceeding 10%, many of these strategies offer attractive returns while managing downside risk through sophisticated algorithms.
Dividend Market Neutral
This strategy combines long positions in dividend-paying stocks with short positions in broad indices to hedge market risk. The result? Consistent income from dividends with minimal exposure to market volatility.
Managed Futures
Managed futures funds leverage trend-following strategies to generate returns across various asset classes, including commodities and currencies. They not only offer an income component but also serve as a hedge during market downturns. In recent years, they’ve delivered yields of 4-6%, with upside potential during volatile periods.
Refining Your Income Strategy: What to Avoid and Why
While exploring alternative income strategies, I generally advise against products like fixed-index annuities, buffered ETFs, and structured notes. These are often marketed as income solutions, but they tend to be overly complex, expensive, and underwhelming in performance relative to their risks. Could they be the right solution for some people? Sure, but be sure to have a crystal clear understanding of the motivations and conflicts of those selling them to you.
Conclusion: Diversify for Sustainable Income
I want to be very clear that nothing in this article is investing advice or an endorsement of any specific investment or asset class. Rather it’s an invitation to look beyond traditional income investments.
If your income portfolio isn’t meeting your needs, it may be time to think outside the box. The strategies we’ve discussed can provide more sustainable income streams and help protect your principal. By diversifying into alternative income investments, you can reduce risks tied to traditional income sources while improving your overall returns.
If this resonates with you, don’t hesitate to reach out. Book a complimentary call with me today to discover how we can work together to create a strategic plan that fits your income needs.
Steven Neeley, CFP® is a senior wealth advisor and founder of Fortress Capital Advisors LLC, a registered investment advisor offering advisory services in the State of Indiana and other jurisdictions where registered or exempted. Tel: (317) 210-3727 Web: www.FortressCapAdv.com E-mail: SNeeley@FortressCapAdv.com
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.
