3 Ways To Earn Passive Income In Germany
You would rather live on passive income instead of working for your money, right? But is living just on passive income really as easy as internet gurus try to make you believe?
- While creating passive income streams is fairly easy, living just from passive income takes a lot of money and patience
- In order to build REAL passive income for yourself, just follow our 3-step formula
- Dividends from stocks & ETFs offer high passive income potential when taking the investment risk
- Interest payments from (fixed-term) savings accounts are much safer than investing in the stock market, but also lower
- Investing in real estate in Germany offers passive rental income as well as the chance for increasing property values
Introduction: The Truth About REAL Passive Income
Building passive income streams in Germany is easy, living just from passive income is much harder than many belief. That is why this article will show you three possibilities for making passive income in Germany. Even when starting with a small budget. So you can chill on a beach with a tasty cocktail in your hand instead of being stuck in a 9-5 job living from paycheck to paycheck. With enough passive income, it is certainly possible that you live the life you always dreamt of and stop working even before retirement age.
The internet is full of (fake) gurus that tell you it is supposedly very easy to get rich tomorrow. You can live off of passive income right after joining their Ponzi scheme, buying their latest course, or “investing” in their own cryptocurrency. Don’t worry, we will not tell you in this article that you should become self-employed with Amazon FBA, write your own book, or start a YouTube channel. It took us about one year before we started making the first cents in ad revenue with our PerFinEx YouTube channel. That is certainly not the path to getting rich quickly.
There is no magic formula on how to get rich quickly. That does not mean it is entirely impossible to earn a little passive income for yourself that may allow you to work less and less active over time. As we are passionate about passive income as well, we wrote down 3 ways how to make real passive income in Germany:
3 Steps To Earn REAL Passive Income In Germany
You would like to have more money without really working for it. Who doesn’t right? The real world just works a little differently than online courses from fake internet gurus trying to make you believe. The only person making passive income is the person selling his courses. If you are really passionate about passive income, here is the truth on how you can build this for yourself.
3 Steps for passive income:
- Step 1: Work hard. Do everything that you can to increase your income from active work. Ask your boss for a raise, try to get promoted, do some extra tasks at work, get a second (part-time) job, etc. The more passionate you are about creating a passive income stream for yourself, the harder you should work. Whatever is necessary, increase your working income.
- Step 2: Save Money. Now that you are earning more money than before, it is time to be clever. Instead of spending the additional money on stupid things you don’t really need anyway, save it. Maybe you can also try to decrease your current living costs even further if you are really determined to live just from passive income.
- Step 3: Invest wisely. Instead of letting your savings sleep on 0% interest rate bank accounts, start investing your money in productive assets. Productive assets are key in your strategy as they can produce cash flow and therefore passive income for you. While you are still working actively, reinvest your earnings to leverage the power of compounding interest for maximum returns.
The truth about passive income is that you need to work meticulously for many years or decades until your nest egg is large enough to support your living costs. These are the 3 steps between your current job that you don’t like doing and that relaxing time on the beach. You need to work hard, save as much as you can, and invest your money wisely. If you are looking for some inspiration on how you can invest your money to achieve passive income, here are our 3 favorite ways PerFinExplained.
Passive Income Source #1: Dividends From Stocks & ETFs
Dividends are a nice source of passive income (in Germany) over a long period of time. The US-American money management company Hartford Funds published a study in that dividends accounted on average for 40% of the total return of the S&P 500 index from 1930 to 2021. Reinvested dividends are even more powerful. 84% of the total return of the S&P 500 index since the year 1960 would be attributed to dividends when reinvested.
Advantages of passive income from dividends:
- As stocks, ETFs, or mutual funds do not require a large upfront investment, to begin with, you can buy them with very little money in the beginning and start earning passive income. You can create an account with any broker in Germany and manage your investment yourself or invest together with us by creating your personal Fidelity investment account completely online in just a couple of minutes.
- As it is possible to start earning (small) dividends with very little money, it is also very easy to diversify your investments. Instead of investing in one single dividend-paying stock or dividend-paying ETF, you invest in multiple different dividend-payers and create a nice diversified portfolio for yourself.
Disadvantages of passive income from dividends:
- When you find an investment that returns 4%/year in dividends, 100€ invested would return 4€/year. 1.000€ invested would return a dividend of 40€ per year, before capital gains tax of course. It will take a long time and a lot of money until you receive a reasonable amount of passive income from dividends, so be patient and let the power of compounding interest work for you.
- Dividends are not created out of thin air, but rather require that the underlying company is making a profit. If that company decides to pay out its profit in the form of a dividend, the paid-out amount will be deducted from the share price (a 100€ share will be worth 96€ only after a 4€ dividend has been paid out). Fundamentally, a dividend is just moving money from the left pocket to the right pocket with Finanzamt in between charging capital gains tax (taxation can be avoided with German pensions).
- The global COVID-19 pandemic that started in 2020 left financial markets in turmoil and showed us that dividends are not guaranteed. According to S&P Global, 62 companies in the S&P 500 decreased their dividends in early 2020 (12,4% of companies) with 41 companies suspending their dividends entirely (8,2% of companies), resulting in $42,5 billion in total dividend cuts.
When choosing your dividend strategy to generate passive income, please remember at all times that past performance is no guarantee for future results. A solid investing strategy consists of a lot more than just blindly investing in high dividend payers thinking that your return will be guaranteed going forward. Because when dividend payers cut their dividends, most of the time the share price is falling as well resulting in a 2-way loss for you.
Passive Income Source #2: Interest From Investments
Aside from dividends, you can build a passive income stream in the form of interest as well. With the current key interest rate from the European Central Bank being very low, it seems particularly challenging to make passive income in Germany from interest.
Advantages of passive income from interest:
- Very similar to passive income from dividends, interest can be earned with very little upfront investment. Hardly any investment has a minimal amount that needs to be invested before interest can be paid out in the form of passive income. If you would like a significant amount of interest, you would also need to invest a significant amount accordingly (of course 😉).
- Interest payments are real payments that are paid on top of your investment value. While dividends from stocks, ETFs, or mutual funds decrease the investment value accordingly (1€ dividend that is being paid out will decrease the share price by 1€), interest payments from e.g. bonds do not decrease the value of the bond. Interest-based investments do not have any ex-interest value like stocks do have their ex-dividend value.
Disadvantages of passive income from interest:
- Generating significant passive income from interest payments sounds good, but it is very difficult at the moment given the low-interest rates in the Euro area. Although interest rates are rising again, the interest rates on a regular bank account in Germany are currently at a maximum of 0,5%, which is still barely enough. Meanwhile, fixed-term savings accounts offer a better opportunity with up to 4% interest (fixed interest rate of 10 years) as seen below.
- As everywhere in the world of investing, past performance is no guarantee for future results. That is also the case for interest payments that are never guaranteed. As long as your bank is going into bankruptcy they have to pay out the interest rate of course, but the amount of interest can change over time according to the terms & conditions for your bank. A very prominent example is that German banks started charging “Verwahrentgelt” in 2020, basically a negative interest rate on your savings of -0,5% (which could happen again in the future).
Best Savings Account In Europe
Best Fixed-Term Savings Account In Europe
Passive Income Source #3: Rental Income From Real Estate
When talking about passive income from real estate it is important to note that this applies to investment properties that are being rented out to tenants only. A home that you purchase to live in yourself will never generate any passive income for you. The eternal myth in the renting vs. buying debate is that you will save on rent payments to your landlord which is kind of like receiving passive income.
If you are buying a home with this thought in mind, you will be buying your property under the wrong assumptions. It is true that you will have paid off your mortgage at some point in time and don’t have to pay the bank anymore, but a home that you live in yourself will always cost you money, even if the mortgage is paid in full. Just look at 40-year-old houses that haven’t been renovated or 40-year-old kitchens and bathrooms to see that a home will always cost you money to maintain.
Advantages of passive income from real estate:
- The undeniable argument to buy investment properties in Germany is the incredible rate of return over the last years. A study from Empirica (an independent German research institute) on the development of German real estate prices shows that regions with a population growth of just +1%/year have almost doubled in value since 2004. Property prices even increased by 31% in regions with declining populations of -1%/year (Postbank Wohnatlas shows similar results as seen below).
- Absolute returns of property prices mostly do not mean much for investors as they leverage their returns with bank loans. Leaving aside the fees to purchase real estate in Germany (notary, ground purchasing taxes, real estate agent), you might make a small down payment of 10% when buying your rental property. If the rental property value increases now by 10%, you basically doubled your money in terms of return on equity.
Disadvantages of passive income from real estate:
- If you are striving like most people for a lot of passive income in the fastest way possible, real estate might not be the right investment for you. As you have to pay off your mortgage, you will most likely not receive a meaningful passive income anytime soon after purchasing your investment property. The lower your down payment, the longer it will take until you will receive passive income from your tenant.
- While it was very easy to diversify with passive income from dividends and interest, diversifying with real estate is very tough to do – especially in the beginning. Most investors buy one property at a time meaning they severely lack diversification at the beginning of their real estate investing career. If something goes wrong with your property in the early stages of investing, you might be in deep financial trouble (or you utilize these 5 affordable ways to invest in real estate).
- Passive income from real estate will most likely never be completely passive. It sounds great that you buy a rental property, and invest almost nothing because you take a mortgage that is paid entirely by your tenant over time, right? That is not how real estate works in the real world. As a landlord, you have to find new tenants, manage your property in case something breaks or needs to be renovated, etc. Real estate can be a lot of work that is underestimated tremendously by first-time property investors.
Conclusion: Which Passive Income Source Is Right For You?
This article showed you 3 possible sources of real passive income in Germany: Dividends, interest, and rental income in alphabetical order. Which of these passive income sources is the right source of passive income for you? (Which one is better: Real estate vs. ETFs)🤔
As ever so often in the world of financial planning, you shouldn’t make this an either/or decision. So instead of focusing on one source of passive income and one source only, you might want to diversify and build multiple streams of passive income over time in order to build your financial future as solid as possible. If our team from PerFinEx can help you to build your passive income streams, feel free to book a free meeting with us.
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