**It would be better if you read what I have written prior to signing up for a brokerage account with Charles Schwab, but if you want to just get started, you can skip down to the section of this page called, Setting Up a Brokerage with Charles Schwab Bank.”
‘Passive income’ is defined on this site as income that is generated without having to put a lot of work into it. Basically, you set it up once, and you are paid regardless of whether you are working or not. Before you get started, there are several things to keep in mind.
First, if you earn passive income in a taxable account, you will have to report your income to the IRS. If you do your taxes through a free service such as turbo tax, it may charge an additional fee for your to file an extra form. If you are not comfortable with filing an extra form, I suggest contacting a certified tax adviser.
Second, there are different ways to earn passive income. In this blog, I talk about earning passive income through investing assets on the stock market. There are funds, stocks, and bonds that give you income monthly, quarterly (every three months), semi annually (twice a year), and annually (once a year). All of these will be considered passive income. I tend to focus on investments that pay monthly in my taxable brokerage. In my Roth IRA and 401k, I focus on other funds that not only pay me (at no specific interval), but also have potential to substantially increase in value. Keep in mind that getting a substantive income through investing is going to take time. This is not a get-rich-quick scheme.
Third, there are different types of investment accounts. Before you invest in an IRA or a taxable investment account, I suggest contributing to your 401k at least up to your company match. I contribute to my 401k before taxes, but whether or not you do the same is up to you. My recommendation is to assess your needs and if you have any questions about what you should do and you can’t find the answer yourself, you should contact a reputable certified financial adviser or financial planner. There are several types of accounts that you can invest in:
Saving Accounts: These accounts are FDIC insured up to a certain amount so there is no risk in putting money in these accounts as long as your balance in that account does not exceed the maximum that the bank is able to insure. The trade-off for no risk is that the bank will pay you only a small amount of interest. There are some banks, however (such as Ally Bank), that currently pay 1.05% interest per year for their savings account. Other banks may pay as little as .2% interest annually.
Certificate of Deposit (CD): You can go to the bank and agree to let them hold a certain amount of your money for a certain amount of time in exchange for a higher interest rate. Most CDs have a penalty for withdrawing before the maturity date. The annual interest is usually around 1.5-2%. Like savings accounts, CDs are normally insured up to a certain amount.
401k Retirement Plan: With some employers, an employee may choose to withhold a certain percentage of their income and place it in investments that are in a 401k. 401ks have less choices for investments than other investment accounts such as IRAs and standard brokerages. Some employers will match an employee’s contribution up to a certain percent. For instance, a company may match an employees contribution up to 3%. This means that if an employee contributes 5% of their income into a 401k, the employer will add on another 3%. Some 401ks allow you to choose whether you put funds into your 401k before or after taxes. If you put your funds in the 401k before taxes, your investments will grow tax free (which could result in more money in the long run), but you will be taxed on your withdrawals. If you put your funds in your 401k after taxes, you will not be contributing as much to your 401k as you would if you contributed before taxes, but you will be able to withdraw from your retirement tax free once you reach retirement age. There is a tax penalty if you withdraw from your 401k before you turn 59 and a half.
Because you are making investments that are not insured, you could potentially lose money from investing, but you could also potentially earn more money than you would if you put your money in a savings account or a CD. Some 401ks have funds or stocks that pay dividends, but not all of them do. Even so, you can potentially save a lot of money over time if the value of your investments grow. There have been people who worked a regular job with a modest income that retired as millionaires because of they were saving money in their 401k. The current limit for 401k contribution per year is $18,000.
Investment Retirement Account (IRA): Like 401ks, IRAs carry a penalty for withdrawal of funds prior to the person turning 59 and a half years old. The tax, however, does work a little different than 401ks. Anyone who is younger than 70 and half can contribute to an IRA. The current contribution limit is $5,500 ($6,500 if you are 50 years or older). With these accounts, you typically will have a lot of choices for investing when compared to a 401k. This makes IRAs a great vehicle for buying funds, stocks, and exchange-traded funds that pay dividends or distributions. Investing in these types of funds could earn you passive income. Once you reach the age where you can withdraw, Roth IRAs do not require you to pay taxes on your withdrawals. rothira.com explains the difference between Roth and Traditional IRAs:
Contributions to traditional IRAs lower your taxable income in the contribution year. That lowers your adjusted gross income, helping you qualify for other tax incentives you wouldn’t otherwise get, such as the child tax credit or the student loan interest deduction.
Up to $10,000 can be withdrawn without the normal 10% early-withdrawal penalty to pay for qualified first-time homebuyer expenses. However, you’ll pay taxes on the distribution.
Roth contributions (but not earnings) can be withdrawn penalty- and tax-free any time, even before age 59 ½.
five tax years after the first contribution, you can withdraw up to $10,000 of Roth earnings penalty-free to pay for qualified first-time homebuyer expenses.
Keep in mind that Congress can change these rules at any time. So while these are the rules today, they may be very different when you retire.”
Setting Up a Brokerage with Charles Schwab Bank:
1. Make sure that you have read what I have written on this page so far so that you pick the right account for you.
2. There are many investment brokers, but in this case, I will show you how to set up an investor checking account and taxable brokerage with Charles Schwab. This account also comes with a taxable brokerage so you will be able to take care of setting up both at once. I chose Charles Schwab because they have great index funds, mutual funds, and etfs. They have thousands of funds that are commission free (although not every fund that you can buy Charles Schwab is commission free). This means that even if you are avoiding commission fees, you still have a lot of quality choices. They also have a 24/7 live customer service phone line and customer service web chat.
3. Go to http://www.schwab.com/public/schwab/banking_lending and select whether you want to have an individual or joint checking account and click on the orange button that says ‘get started.’
4. The next page will show what is required for you to be able to set up your new checking account. If you do not have a login ID for Charles Schwab, click on the ‘I’m new to Schwab’ option. (If you have an account but you are not sure how to set up a brokerage or checking account, contact Schwab customer service and they will help you set it up. The rest of this walk through will assume that you do not have an online account with Schwab).
5. Fill out the information (or at this point you can contact customer service through their web chat or phone line).
6. On the next step, I recommend saying ‘no’ on margin borrowing (debt is bad and it is not a good idea to borrow from the investments that you are trying to make money with in the first place) then move on to the next step.
7. Review terms and conditions and then accept if you agree and move on to the next step.
8. Provide banking information so that you can transfer money to your account if needed.
If you’ve made it this far, congratulations on taking your first step to building a portfolio that will give you passive income. What you invest in is up to you, but I do have a public list of what I have invested in and I have an article that lists 14 funds that pay you monthly if you would like some places to start. Some funds, stocks, and etfs, require a fee to invest, but there are a lot of funds and etfs that do not require any up front fees (there is an expense ratio but it comes directly out of your investment holdings and if you choose funds that have a low net expense ratio, you will save a lot of money. I recommend avoiding funds that have a net expense ratio that is higher than 1% (I prefer .75% or less). I only have one fund that has an expense ratio higher than 1%; I picked it anyway because of how well it performs. You can also choose to invest in funds that pay you monthly, quarterly, semi annually, or annually if you want passive income. I try to stick with monthly payment funds on my brokerage account and I vary my strategy a bit more in my Roth IRA. You can also open up an IRA through Charles Schwab by using their website or by contacting them and requesting that an IRA account be opened. If you open an IRA, I recommend a Roth IRA instead of a Traditional IRA. Remember, Charles Schwab has a 24/7 customer service line and web chat that can answer any questions you have.