Hello, everybody, it's Sam from Financial Samurai. And in this episode, I want to talk about the best silver lining from this bear market. And the best silver lining from this bear market is that it's easier to generate more passive income in a bear market. You know, obviously, it stinks to lose money in a bear market, whether it's paper losses or real losses.

But the positive really is that we can all generate more passive income. And given we can all generate more passive income more easily, we can also get that much closer to financial freedom. And if you are already financially free, the definition of having enough passive income to cover your living expenses, then this extra passive income provides just an additional buffer to stay free.

The 2022 bear market is clearly caused by the Fed. The Fed should have probably hiked a little bit in 2021, and then more in 2022. So it would be more gradual and less sharp and jolting. But what's done is done. Interest rates go up to counteract inflation, risk asset prices go down.

Pretty simple, because higher interest rates mean there's a greater discount rate of future cash flows, which reduces the value, the present value of a company today. But here's the thing, folks, when interest rates go up, everything from bond yields to dividend yields also tend to go up. And the reason why is because every yield is relative to the risk-free rate of return.

And the risk-free rate of return is the 10-year government bond yield, which is over 4% today. Back in March 2020, it was about 0.6%. So it's clearly risen a lot, a lot over the past 12 to 18 months in particular. No rational investor would invest in a risk asset if they could get a higher or equal risk-free rate of return.

To take on risk, you need an equity risk premium. Otherwise, you just wouldn't bother. As a result, investors should be able to generate more easily passive income when interest rates are higher. Let's look at corporations, for example. They issue bonds to raise capital to pay for operating expenses, maybe acquisitions, and maybe just to boost their balance sheet, especially when interest rates are low, because that means they pay a lower interest rate.

However, to stay competitive with government bond yields, they need to pay a higher coupon rate. Otherwise, people would just buy risk-free treasury bonds. Corporations may also have to increase their dividend payout ratios to increase stock dividend yields as well. Again, and that is to attract that capital to buy that stock, because the alternative looks much, much better now with risk-free rates higher.

In regards to real estate, cap rates need to go up to make the property more attractive compared to the risk-free rate of return. Let's say the risk-free rate of return, again, is, let's say, 4.1%. If the cap rate is at 3%, I mean, why would you bother buying a rental property if you can only get a 3% rate of return when you can do nothing and earn 4.1%?

Everybody who is a landlord knows that managing tenants, managing maintenance issues can be a hassle. So, we need to be rewarded for that hassle with a higher cap rate. So, if rents don't go higher to generate a higher cap rate, then property prices should adjust downward. This is just natural market forces at work.

In general, landlords are a big beneficiary of inflation over the long term as real estate prices and rents increase. Inflation acts as a tailwind. However, in this case, inflation has gone up way too quickly, and it's resulted in higher Fed funds rates, higher interest rates hikes. If the Fed didn't raise rates, then actually, probably property prices and rent prices would continue to go at pretty gangbuster rates, and then that would be a detriment to the majority of the population who are not rental property owners.

That would just be bad for the middle class. So what I've just described here is the crowding out of private capital. This is an economic term, crowding out, where higher interest rates on the risk-free rate of return crowds out the capital that would have gone to the private sector, to companies, and now is going to the public sector or treasury bonds because they're more attractive on a relative basis.

In the past, I would regularly invest majority of my cash flow in the S&P 500 and in private real estate funds. Those are the two investments, risk assets that I like to invest to earn 100% passive income. These two types of investments generated yields of between, let's say, 1.5% with the S&P 500 dividend yield when it was 25% higher and 10% on average with private real estate.

However, now with higher interest rates, government bonds are crowding out private capital, my private capital. Instead of mostly investing my cash flow in the S&P 500 and private real estate funds, I've earmarked 60% of my cash towards buying treasury bonds. And hopefully you read that article that I wrote talking about treasury bond buying strategies.

I think there's probably like a 70% chance that the 10-year treasury bond has peaked at 4.3% and is going to roll over. So it's something to think about locking in one, two, three-year treasury bonds at 4% for your treasury bond asset allocation or for your cash allocation. I think that's pretty smart.

But 40% is still being invested in risk assets, right, if I'm investing 60% in risk-free assets. But that percentage before the interest rate hikes used to be closer to 80%, 90% of my cash flow in cash were being invested in risk assets. So it's clearly come down to 60%.

Might come down even more depending on what interest rates do. If you click over to the post on generating more passive income in a bear market, you'll see this really great chart that shows the two-year treasury yield now 280 basis points higher than the S&P 500 dividend yield. So again, as an investor, you're deciding, should I invest in stocks with like a 1.8% dividend yield now or should I invest in a two-year treasury bond that's yielding 280 basis points higher, 2%, 3%, 4.5%, something like that.

And I think obviously more investors are going to shift some of their capital to risk-free 4.5% treasury bond yield. It just makes sense. It's because everything is relative to something else. The other interesting thing is the money that could have gone or would have gone to growth stocks, which have just gotten crushed in 2022, now is also probably more going towards higher yielding bonds or higher yielding stocks because there's fear, there's uncertainty, who knows about interest rates.

And so people don't want to chase high value growth because growth is getting crushed. One real-time example is Alphabet, a parent company of Google, reporting third quarter 2022 results today after the close, October 25th. And they missed on the top line and the bottom line, and their margins are shrinking, and they're just losing to TikTok.

And it's not looking that good, right? Google used to be the ultimate growth stock, and now the stock is down, what, 5% to 8% after hours. And so people are wondering, OK, Google, you're not growing as fast as you are. You have a huge market cap. Should you start paying a bigger dividend or a dividend?

That's probably something they're considering now, given that they have huge cash flow and a large balance sheet. But look, you can lose literally 5% to 8% of your money on Google stock if you had bought yesterday and then they reported results, right? So this is a risk, and this is a risk that we all know about.

And there's more risk with growth stocks than dividend yielding stocks. And then there's more risk with dividend yielding stocks versus holding treasury bonds. So whether you want to invest in treasury bonds, municipal bonds, corporate bonds, stocks that pay a dividend, yields are all going up because it's all relative to the risk-free rate of return.

Now some of you, I've seen the comments on Facebook, on Financial Samurai, saying, oh, well, if you buy a bond at a 4.5% yield, you're still losing in real terms, right, because inflation is at 8%. So you're losing negative 3.5% of buying power. Well, sure, yes, that is a loss in real terms.

However, making a nominal return, let's say 4.5%, is still better than actually losing money. Wouldn't you rather make 4.5% versus losing, let's say, 25% in the stock market year to date so far? Of course you would rather, right? I mean, thank goodness we put $10,000 each in IBONZ at the end of 2021.

We did another $10,000 at the beginning of 2022. That has saved us, but too bad those are the limits, $10,000 per person per account. So moving forward, if you're not buying a Treasury bond yielding 4.5% risk-free, and you're buying stocks or any other risk asset, then that means that over the next 12 months, you believe that risk asset will return greater than 4.5%.

Otherwise you shouldn't be buying it. Now of course, nobody knows the future for certain at all, which is why we diversify. So for me, as a semi-retiree, I call myself a fake retiree because I'm still generating cash flow online, I have shifted 60% of my cash flow to risk-free assets.

4.5%? Pretty good. My target is 5% to 10% returns a year. So 4.5% is almost there just with no risk and do nothing. Awesome. And I've got 40% still in risk assets because I still think we should be buying stocks after 25% decline, so you're nibbling on real estate if you've seen some opportunity.

And over the long run, stocks and real estate tend to do well. But the risk is over the next three to five years, maybe a decade, the returns for stocks might not be as good. But the good thing is you've read Financial Samra, you've listened to this podcast, we talked about lower expected returns.

We talked about Vanguard's forecast. We talked about Goldman's, Bank of America's. They're talking about 4% per annum stock returns and bond returns of like 2% to 3%. And so far, that's probably going to be correct because we had a terrible 2022 so far. So don't confuse brains with a bull market.

These things go in cycles. You have to diversify, but you also have to invest for the long term. All right, finally, I need you all to calculate how much more passive investment income you can generate over the next 12 months. Do some performance analysis, see what your savings rate is, how much you're going to save every month.

What if you invested in various types of assets? How much more do you think you can generate? I think you could probably generate, well, actually, it depends on how big your investment amount is currently and what your cash flow is. So from my perspective, I know I can boost my overall passive income by about 10% or about $35,000.

The increases are mainly coming from treasury bonds, private real estate investments, and rental property income. So far, I've invested $250,000 in treasury bonds, so that should generate another $11,250 a year. My Sunbelt rental property income is rising from about $50,000 a year to $60,000 a year. Given higher mortgage rates are pushing more people to rent.

Check out Fundrise, financialsamurai.com/fundrise for more. My Lake Tahoe vacation property, which has been a dog since 2007 when I bought it, right before everything collapsed. I was just putting into my estimates $500 net rental income a month. But since there are no more COVID restrictions, tourism is booming again, right?

I went twice myself over the summer and it was pretty busy. So that rental income has gone from $500 to $650 a month to about $1,500 a month and sometimes a lot more. I'm just trying to average them out. And then finally, I've got one rental property where I've boosted rental income from $6,700 to $8,000.

$300 of that is probably due to the market, while $1,000 of that is due to a rebuttal. And then finally, I have venture debt investments. I'm just submitting my capital calls every single time there is a capital call. As a venture debt investor, you also benefit from higher interest rates because the return is also pegged off the risk-free rate plus a markup.

So please run a performance analysis on your current passive investment income and how much more you can generate. This is really the silver lining of the bear market. If things don't get too bad, in other words, if the S&P 500 doesn't decline by more than 35% from peak to drop-- so we're talking about 3,000, 3,200 S&P 500-- there probably won't be tremendous amount of layoffs.

The global financial crisis is like right now minus another 20% down. And then all of your friends are getting laid off left and right every single week. That was the global financial crisis. So we're not there yet. And I don't think we're going to get there. It doesn't feel nearly as bad.

Once the bull market returns-- maybe that's in 12 months, 18 months, who knows? Maybe it's two years-- investment yields will likely go down as asset prices rise. In such a scenario, you're still making the same amount or more in passive investment income. However, your portfolio value has gone up, which is going to be obviously the best of both worlds.

So so long as you have regular cash flow and things don't get too bad, you're always winning. Because your net worth, your portfolio value is pretty subjective now, right? One day it was worth x, and now the next day it's worth x minus 25%. And in some companies, x minus 90% is just devastation with some companies.

But if you can focus on your cash flow, that's what matters most. And you will realize that matters most when you no longer have a steady paycheck. If you don't have a job, you don't have a pension. That's basically what I'm experiencing right now. I really have focused on cash flow generation.

The net worth growth feels great when it's going up. It doesn't feel as good when it's going down. But really, trying to manage and keep sticky and grow that passive income is what we should all be focused on. If you're still working day job and you're investing in growth stocks, even dividend stocks, this bear market is a good reminder to start selling down some of your risk assets and shifting it to risk-free assets probably three to five years before then.

You want to kind of chop it up. You don't want to miss the bull run. But at the same time, you don't want to just be like, oh, I plan to retire in 2022. And then boom, you've got a 25% hit to your stock portfolio. Depending on when you bought your real estate, your real estate portfolio is probably going to fade 5% to 20% over the next 12 to 18 months.

You don't know for sure, which is why you need to shift those risk assets to risk-free or lower risk assets the closer you get to retirement. All right. And speaking of retirement, if you want a great software to help you retire better, to go through the nitty gritty, to see many type of what-if scenarios, check out New Retirement.

You can go to financialsamurai.com/nr. It's really one of the best retirement planning tools out there. And it's specifically for retirement. Also, shout out to Fundrise. Fundrise posted their third quarter 2022 year-to-date returns. And all clients are up 5.4% versus public REITs down 28.34% and public stocks, the S&P 500, down about 24%.

That's through the third quarter. This outperformance in a bear market is one of the main reasons why I invest in private real estate. In 2018, Fundrise, all clients, the portfolio was up 8.81% versus public REITs down 4.1% and public stocks down 4.38%. So when you're investing and you want to diversify, you want to invest in things that zig when others zag, right?

And so this is what Fundrise has been able to do. So now you've got two really good years of outperformance during down years in the stock market. And I expect this type of outperformance to continue when the stock market is down because Fundrise is vertically integrated. They invest in undervalued properties in the Sunbelt.

They buy and hold properties for rental income, which is much stickier. They buy and rehabilitate properties to boost property values and rents. They have an experienced managed team that is able to identify strong buying opportunities. And they're also easily able to raise funds to purchase properties with cash at a great price.

So again, if you want to check out Fundrise, go to financialsamurai.com/fundrise. All right, folks, I hope you enjoyed this episode. Leave a comment. Love your positive reviews, and I'll see you all around.