Beginner’s Guide to Passive Income (10): Risks and Suitability?

Continuing from the last post, everything has risks, and everything has a price. I thought this was common sense, but over the years, it seems that when this reality hits, not many people can accept it. Investing comes with risks! Otherwise, how could we call it investing? It should be called (some) government bonds or GICs (Guaranteed Investment Certificates) 😂

I have always believed that the art of investing is balancing risk and reward. Wins and losses are part of the game. As long as you are in this game, there will always be profits and losses. That is normal. Only making profits and never losing is a fairy tale, not reality. As long as, over time, the wins outnumber the losses and the rewards outweigh the losses, then you are on the right track and can continue to refine this art. Therefore, the key is to reduce risks and increase the odds of winning, not to pursue unrealistic goals of completely avoiding risk. Let’s face it: without risk, where would the rewards come from? Returns are a compensation for bearing risks!

So, in this post, I want to specifically discuss risks. You can then decide on your own if this is the game you want to play, or if you should play. 

First, a simple and straightforward indicator is whether you can afford to lose your principal. If this is your bottom line, then you should not get involved in any investment, whether passive income or active income! Don’t just think about the comfort of passive income, think about how you would feel if you really lost your principal. I often have this kind of conversation with others:

Someone: Cindy, I want to invest, are there any principal-protected options? 

Me: No-low risk low reward, high risk high reward. If you want protection, GICs or government bonds are more suitable. 

Someone: But the return is too low, do you have higher returns? 

Me: Yes, low risk low reward, high risk high reward. Which one do you prefer?

Someone: Are there any principal-protected options? 

Me: No, you should really consider GICs or government bonds

 Someone: But the return is too low, do you have anything else?

And then this conversation continues in circles.

So, it’s simple. If you are completely unwilling to bear the loss of your principal, please do not make any investments! Don’t bother reading my content or anyone else’s, just buy GICs or government bonds, relax, and don’t worry about your principal! For people like this, don’t complain about the low returns, even though they are low, they can meet your core needs!

If you are the type who is willing to bear a certain amount of principal loss in exchange for potential higher returns and more options, and you have spare money that you can afford to lose without affecting your life and emotions, then the passive income and alternative asset paths I talk about are worth considering. At this point, it’s about analyzing specific assets and their risks and potential returns to see which ones are worth your while.

One common risk across all assets is the risk of the operator running off with the money (put simply, fraud). Additionally, if it’s a fund, there’s an added third-party risk of the fund manager running off. That’s why I generally don’t invest in funds and prefer to invest directly with the operator. We also avoid acting as third parties ourselves because it’s not worth our time and effort to explain all these, so we simply make the contact details of the operators available to anyone that contacts us, so everyone can do the due diligence themselves and make their own decisions.  If you don’t want to bear the risk of the operator running off, then go for public markets like stocks, which is outside the scope of our discussion.

To reduce the risk of the operator running off, you need to evaluate the operator’s historical data, performance, behavior patterns, their profit model, etc. You can then make adjustments to your position based on these factors.

Next, there is the risk of the asset itself. This is the part I enjoy researching the most because many industry details determine the level of risk, and these details are only uncovered through thorough research and sometimes, luck. For example, who would have thought that legal lending cases could be fully insured by a third-party insurance company (other than car insurance companies)? Or that most of the cases don’t even go to trial and are settled for compensation? Or, in copyright litigation, who would have thought that there are insurance companies that cover judgments before an appeal, making the appeal almost a guaranteed profitable venture? I shared all these details in my series on these strategis. If you’re interested, you can take a look.

Once you understand these details, what seemed like risk to others may no longer be a risk in your mind, or its level of risk has diminished. The risk is still the same, but my understanding of it, due to the additional details and information, is likely very different from the understanding of an ordinary person. This is why I always say I prefer low-risk, high-reward opportunities because, in my own cognitive framework, low-risk, high-reward truly can coexist!

If you dislike what you are doing now, passive income can indeed free you from work and allow you to pursue things you really want to do; or if you want to focus more on your family, passive income can give you more quality time with your children, partner, and parents, without worrying about money; if you don’t want to be caught up in the market’s ups and downs, where your mood feels like a constant roller coaster, passive income can indeed bring you inner peace and allow you to live on your own terms. I live off passive income, and what I love most about it is the freedom and peace it brings. It gives me time freedom, location freedom, and the ability to choose what I want to do and whom I want to do it with, whether it’s for hobbies or spending time with my family, all without worrying about money coming in regularly.

However, don’t have unrealistic expectations for passive income. Building passive income that suits you is a process, and this process takes time. Passive income will not make you rich overnight, unless you’re going all in on one big bet, in which case it’s gambling, not investing. The process of building a passive income strategy that fits you involves learning, diversification and iterative testing, and adjusting your positions and allocations based on the results that unfold over time.

So if you think you meet the above conditions and are willing to give it a try, how should you start? In the next post, I’ll discuss allocation strategies, specifically: what to do, how to do it, what others are doing, what I’m doing, and how you can do it too. Till next time!