59: How to Generate Your First $1,000 of Passive Income

0:00This is a real good story about Bronx and his dad Ryan, Real United Airlines customers. We were returning home and one of the flight attendants asked Bronx if he wanted to see the flight deck and meet Captain Andrew. I got to sit in the driver's seat. I grew up in an aviation family and seeing Bronx kind of reminded me of myself when I was that age. That's Andrew, a real United pilot. These small interactions can shape a kid's future. It felt like I was the captain. Allowing my son to see the flight deck will stick with us forever. That's how good leads the way. Shopping is hard, right? But I found a better way.

0:33Stitch Fix online personal styling makes it easy. I just give my stylist my size, style, and budget preferences. I order boxes when I want and how I want. No subscription required. And he sends just for me pieces, plus outfit recommendations and styling tips. I keep what works and send back the rest. It's so easy. Make style easy. Get started today at stitchfix.com slash Spotify. That's stitchfix.com slash Spotify. Hey everyone, Robert Croke here. The title of this episode is How to Generate Your First$1 ,000 of Passive Income. And that's exactly what we're going to help you do. This episode is actually an interview with Troy and Garrett from the NEOS Investments Funds.

1:15And you hear us talk all the time about SPYI and QQQI. So we thought we'd bring them on the show to help break down your questions about these incredible funds. We talk about their total returns, option strategies, tax efficiencies, and even lay out a clear example with real numbers that will get anyone listening right now to that first$1 ,000 in passive income. So let's jump into the show. Hey everyone, and welcome back to the Rich Habits Podcast, a top 10 business podcast on Spotify. My name is Austin Hankwitz, and I'm joined by my co-host, Robert Croak. Robert is a seasoned entrepreneur in his 50s with lifetime revenue of over$300 million under his belt, and I'm an entrepreneur in my late 20s with a background in finance and economics.

2:00Since quitting my full-time job in corporate finance a few years ago, I've built a seven-figure media business and actively advised some of the most well-known fintech companies around the world. As the show name might suggest, every episode, we talk about rich habits as they relate to business, finance, and mindset. However, we try and bring you two unique perspectives. One from an industry veteran, which is Robert, and the other myself, someone who's still in the process of building wealth and figuring it all out. So Robert, what are we going to be talking about in today's podcast episode? In this episode of the Rich Habits Podcast, we're going to be talking about how anyone listening right now can generate their first$1 ,000 of passive income.

2:38You hear us say all the time to build your base of that first 100K. Well, building your first$1 ,000 in passive income is equally as important. So joining us to help explain things today is Troy and Garrett from Neos Investments. If you tuned into our webinar last week, you'll remember just how knowledgeable these fellows are as it relates to generating passive income. Troy, Garrett, welcome to the show. Thanks for having us, Austin and Robert. Pleased to be here. Yeah, man. We are super excited. We got a lot of positive feedback on your guest appearance on the webinar. We talked about how to build an investment portfolio from scratch.

3:13There's going to be a link in the show notes below for everyone to go watch the replay there. I think over 600 people already have. Listen to this, guys. We had over 700 people join us live, over 600 comments, a bunch of shares, a bunch of discoverability. It was a lot of fun. We are crushing these webinars. We can't wait to do more, of course, with Troy and Garrett as well. But this episode is about something a little bit different, right? The webinar is about building an investment portfolio from scratch, but this is going to be about generating your first$1 ,000 of passive income. Now, in my opinion, it's a really simple equation, right?

3:47To generate your first$1 ,000 of passive income over the next 12 months is you open a taxable brokerage account on public.com and you buy the ETFs that these guys have created. But on a serious note, I want to talk about not just what the ETFs are, as well as how they work, what to consider for taxes, and how anyone can begin to leverage this information to retire early, something I'm trying to do myself. Love it. So let's start off, and either of you or both of you can chime in on this, and that is, what is an ETF? What is SPYI, which by the way, just passed$1 billion in assets under management.

4:20So congratulations. And how much of a yield did it generate for its investors in 2023 and break down like we did on the webcast of what that means and the total return? So an ETF stands for an exchange traded fund. And really what is an exchange traded fund? It is exposure in one fund, one investment in your portfolio that gives you exposure to a basket of securities, whether those are equities, whether those might be bonds, maybe a mix of the both. For us here, we like to use options and NEOS actually stands for Next Evolution Option Strategies. So we like to take those core exposures, that basket of potential securities like the S &P 500, add an option strategy on top of it to generate really tax efficient monthly income.

5:07And so obviously we're talking today about passive monthly income. But that ETF is really a one investment vehicle that could give investors exposure to a broad base, a diversified portfolio of underlying investments with a low amount of capital initially allocated into a fund, maybe one share, which one share could be represented of maybe$25 or$50. And then you're able to spread that across hundreds of investments that you normally would not. So the ETF is really a great vehicle for investors for getting exposure to a certain type of security, diversification. They come with lower costs than other type of fund structures.

5:41They have full transparency of what the underlying holdings would be. And they're really the kind of path forward that most investors are using to gain exposure in a certain asset class. But I'll let Troy talk a little bit about SPY specifically. Thanks, Garrett. No, SPYI is a NIO's S &P 500 high income ETF. This is an ETF that we launched in August of 2022. And we've had some really nice growth in the ETF. And that's really important when you're looking at option-based ETFs. There's a number of them out there. And when you're thinking about investing in these ETFs, you have to do your homework because they're not all created equally.

6:13Some of them put out higher yields, lower yields, but in the end, you want to look at that yield number, that total return number, and what kind of tax efficiency you can get off of an ETF like this. So for this ETF, for SPYI, we're basically along the S &P 500 equities. We're along all 500 plus equities in the same weighting as the S &P 500. So we're really trying to track the underlying equity index of the S &P 500 with those holdings. Where we bring the income in is our active covered call strategy. So on a monthly basis, we're writing calls on the S &P 500 index. So we're using those index options for that tax efficiency, for that liquidity.

6:48And we're using those index options to bring in income and then distribute out that income to the shareholders. Since launch, we've had a pretty steady distribution of just about 1 % a month. So as Robert had mentioned earlier, talking about total return, talking about what kind of distributions we had for last year for 23. So we distributed just over 12 % for 2023. And that's distributed monthly in that 1 % distribution. So, Troy, what you're saying is SPYI, to your point, essentially owns the S &P 500, right, which is the 500 largest, most profitable companies in the United States. You guys are benefiting from their success over a long period of time, like the S &P 500 has shown.

7:27but you're sort of focused on the income side of the equation. By doing that and staying focused on that, you are sort of selling covered call option contracts against these holdings, allowing you then to pay investors on a monthly basis. Correct. That's exactly how we think about it. And real quick, I want to bring up something on this before we move on to the next point. If someone doesn't want to take their distributions, does it automatically roll over? I saw that a bunch in the comments last week. So just touch on that for a second. Sure. So if an investor doesn't want to take that monthly distribution, they want to reinvest it into the fund, they can go on their platform wherever they do their investing.

8:03And there should be an option for them to reinvest that monthly distribution. And if there comes a time a year, five years down the road where they want to start having that monthly distribution, they could turn that off and start to take that distribution on a monthly basis. No, that makes a ton of sense. Sure. If I want to take, I mean, you guys are paying distributions to shareholders, period. So it's like, I'm making this money anyway, I have to take the money. But when I take the money, I have the opportunity to withdraw it into my checking account and spend it on things like my utilities bill, groceries, or put gas on my car.

8:33Or I can take this money and reinvest it and buy more shares of these ETFs, which then will compound on itself, pay me more and more money because I have more and more shares, right? So we're talking a little bit about taking this money and using it now to pay for everyday things like I put gas in my car. I actually use your ETFs to help with that, which is great. Talk to me about taxes though. How are these distributions? How is the money that I'm putting into my checking account taxed and even treated in the eyes of the IRS? Yeah. So that's a big focus as Troy was alluded to. We look at this tax efficient month income.

9:05And so when you break down kind of the average 1 % a month that's being distributed, first and foremost, we do receive all of the dividends off the equity paying stocks. And so those are taxed as a qualified dividend. That means you're taxed at anywhere from zero to 20 % because it's a qualified dividend coming from those companies. Secondarily is our options. We use index options. So that on for SPYI is linked to the S &P 500. So those are SPX index options. They actually get a preferential tax treatment from the IRS. If you really want to look into it and learn more, you can look up section 1256 in the And that would let you know that any gains and returns and income we're generating from the options, regardless of our holding period of those positions, get taxed at 60 % long-term capital gains rates and 40 % short-term.

9:54So a nice tax advantage on that. Something we could certainly discuss later is we also look to leverage a tax classification that some investors know about and some don't called return of capital. And don't think of return of capital as simplistically as returning capital. This is not returning you your initial investment. We want to have a classification of our returns as return of capital. What does that mean? In short, it just takes all of your investment returns that could be short-term, ordinary income, et cetera, and convert it into a long-term capital gain when you sell the fund. So we could talk about that more later, but then that's the third element is a return of capital is a really interesting and unique opportunity in all these funds.

10:31So you're getting the most of your net after tax return from these funds to fill up your car with gas, buy groceries, pay your utility bills, et cetera. We really think about at NEOs, how to take your gross return and bring as much of that home in an after-tax standpoint, because that's meaningful to every investor, regardless of size or tax bracket. We want to look at allocations where people are either benchmarking their portfolios to or have large allocations to now. And how do we aid in the income generation in a tax efficient manner to produce passive income is really what we're looking to do.

11:02So you could choose exposures with the S &P 500 with us. You could look at the NASDAQ 100. We even have products on the fixed income side. If you're looking to augment your fixed income or bond portfolio, or even things where you get alternatives to money markets with CSHI. So for us, we really want to look at those core building blocks and find ways to create additional tax efficient monthly income where you're already comfortably allocating. I love it. So for people listening right now, the episode is titled how to generate your first thousand dollars of passive income. Theoretically speaking, QQQI is an ETF that you all have.

11:36And this ETF, the underlying index is the NASDAQ 100. And you guys have now paid out two months of distribution since its inception back in February. And your distribution yield on a forward 12-month basis is about a 14 % yield. So assuming that someone invested$7 ,200 into the fund and you guys theoretically were able to keep up with this 14 % yield, that would be$1 ,000 of passive income over a calendar year, right? So 7 ,200 turns into $1 ,000 of yield. And then what's cool about that too is, you know, you mentioned return of capital earlier, and I want to make sure people understand sort of how this works.

12:10Your$7 ,200, you know, if you invest that into an ETF, one of their funds or not, and it pays you a monthly dividend or distribution or whatever you're getting paid here, that's not coming from the value of your investment, right? So the 7 ,200 isn't going down by 1 ,000 to 6 ,200. The 7 ,200 stays the same, but then you're getting paid$1 ,000 on top of that over that same period of time. Is my math correct here, guys? Correct. Yes. We're sourcing the income that's paid out in the distribution from the options market. So yes, in that example of being long QQQI and having that$7 ,200 invested, the goal for that is for your underlying holdings to continue to grow as the NASDAQ 100 grows, but source that income from the options market on the NASDAQ 100 and be able to pay that out on a monthly basis.

12:58Okay, so I'd like to jump in for a minute and really talk about what should the average investor expect if they're putting X amount of dollars into the SPY versus SPYI or also QQQ versus QQQI, what happens in upwards trends, downward trends, or a flat market? And should they own both in their portfolios? portfolios. So I think it's beneficial that if you're looking to be a long-term investor, owning both in your portfolio is great. SPY or QQQ are just simply the long-only equity benchmarks that give you exposure to those indexes. And so it's positive to have a long exposure to that. Where SPYI or QQQI come into play is really helping to generate that income, right?

13:44The passive income part of your portfolio in a very tax-sufficient manner. So depending on the amount of income you want relative to your growth, it's really up to an investor to choose what their percentage allocation. Naturally speaking, if you're potentially an older investor, that income need might be higher than maybe a younger investor. So depending on what your allocations are on income relative to upside growth, we do like having the ability to pair both. What happens with SPYI and QQQI, our products, in an upward trending market is that you will capture, depending on the velocity of that upside market, the majority of that or a portion thereof of the equities.

14:19And at some point, we give up a little bit of that equity exposure, that upside, to be generating that income. So you will not get that same full equity replacement that you're getting from owning SPY or QQQ because it's not just a long-only. We have to generate the income in some way from the options. So you're willing to give up a little bit of that. And let's say, generally speaking for those products, we might have options that are anywhere from 1 % to 4%, 4.5 % away from where the market is on a monthly basis, meaning you would get all that appreciation of the market up that 1 % to 4%. Then we would start to give up a little bit of that for that income generation.

14:57So when you think about the products, they're really that you gain a significant amount of the equity appreciation in upward rising market, but you do have to give up some for the tax efficient income generation. So again, that's where you pair the percentages based on your needs. In a flat market, this is where SPYI and QQQI really perform well because if the S &P was perfectly flat over the course of an entire month, we should generate somewhere between one to one and a half percent of income from the options that month. So if you think about the SPY being flat, then we'd be up about 1 % to 1.5%, including that monthly distribution.

15:33Same for QQQI. In a downward market, you're going to get that income still distributed to you. But as a total return, it's going to look like a slight buffer to your portfolio. So let's just say the S &P was down 3 % and we had generated 1.5 % of options income. SPYI in that case would be down 1.5 % versus the S &P being down 3%. So you're kind of getting a lower volatility. You're getting this high tax-efficient monthly income. But in the times where it won't look like it competes or outperforms, it's certainly a very strong bull market where you give up some of that upside to generate the current income.

16:08That makes a ton of sense. And I think that's really important for people to understand, right? Because when you look at the price of QQQI versus QQQ, and you just look at pure price return, same deal with SPY versus SPYI. It's kind of deceptive. 2023, you guys delivered over 18 % total returns in SPYI. I think a lot of people in our webinar last week were like, wait a second, I'm looking at the price return of some of these. And so like, I don't see that in the price, but that's because it's getting paid out as income, right? That 1 % per month, 1 to 1.5 % per month on average there to these investors.

16:41Whereas yeah, the price does trend higher over time because when you're writing covered calls out of the money, as well as not on the 100 % notional value of the portfolio, allowing the portfolio to trend higher over time. So I think that's really important for people to understand that price is one thing. Total return is a completely other thing. And I'd argue a much more important statistic to look at. Absolutely. We think that's a really key component for anyone, whether it's our funds or actually any fund out there. It's really important that if a fund has a distribution rate to it and anything, of course, that's more than maybe just 1 % or even sub 1 % on QQQ, just a regular long only, to make sure that you're always incorporating a total return, a full look at what the distributions plus the price return has done to get that whole total return for your portfolio.

17:26And listen, a lot of platforms don't always represent that when you just quickly look. It might just be calculating the price return. So it's always important to look at your statements and make sure you've understood that the distributions received also should be incorporated into that. Yeah, I love that. And these breakdowns, I think, really help our listeners understand why we love SPYI, QQQI, and some of these offerings from NEOS funds. And I just like the fact that you're not trying to replace or transform portfolios, but instead you're just trying to show us how to create these great complements for an investor to their already built portfolio or a newer portfolio.

18:04So can you break this down a bit? How did this complimentary approach influence the decisions you made with the ETS that you've created? That's a great question. I think as we look at it, looking at SPYI and QQQI, how do we take these great indexes that have a great history of total return performance and how do we add on to those? How do we complement those by bringing in an option component for us and actively manage rules based systematic option strategy that we use to bring in that income? And when you're looking at an investor's overall portfolio, what they're trying to accomplish, we started with the S &P 500 with SPYI because we think that's a core holding in most people's portfolios.

18:43Most people, when they think about investing in the stock market for the first time, that's usually where they kind of focus in on, do I own an S &P 500 exposure or fund? So we wanted to really bring this out first when we launched it about a year and a half ago and say, this could be a complement to your S &P 500 exposure. We could give you a lot of the upside participation as the market moves higher, but still bring in that tax efficient income and help you and complement your portfolio overall. Whether that's you wanting to bring in income now or maybe later down the road, or maybe you want to lower the volatility of your portfolio with an option based ETF like this.

19:17I love that. And thank you for explaining it, because, you know, we are chartering some new territory with some of these ETFs. And I really love the performance and how you guys really break it down. And the fact that it's complimentary, I always say everyone in their portfolio should own the S &P 500. So that just gives them another way to do so, but also get these additional gains through this option based strategy. So very important. And thank you so much for joining us and really breaking this down for our listeners, because, you know, Austin and I, every single day of every week for the Rich Habits podcast and our communities are really looking to find the best of the best breed out there of ways for people to find additional gains in their portfolios, but also make sure that they have and cover diversity so that way they can withstand the good, the bad, and the ugly in all of the different market conditions.

20:13So thanks for joining us again. We really appreciate your time in explaining these ETFs and help people get to that first$1 ,000 of passive income in their portfolios. Now, we've talked about generating the first$1 ,000 of passive income. We've talked about SPYI, QQQI. They're awesome ETFs to help everyone listening right now hit that very, very important benchmark. But Garrett, I think I heard you allude to something called return of capital. I know that taxes are very important for people listening, especially as they get a little bit older. They want to make sure that the yield they're seeing is the yield they're getting.

20:49Can you talk a little bit about return of capital and explain to the layman listening right now what that means, not only from the eyes of the IRS, but when it hits their sort of bank account, what's the percentage that they should really be thinking about setting aside using maybe 2023's figures as a benchmark there for SPYI? Sure. Yeah, that's a great question, Austin, and give it as simple of an answer as I can. Of course, always consult your tax advisor or your accountant because everybody's positions are always unique to them and specific. But so as we think about return of capital, as I mentioned, return of capital, don't think of it specifically as the words return of capital.

21:24From a tax designation standpoint, a return of capital means you've received a non-qualified distribution, meaning that that distribution is not taxable in the current tax year. So you're getting a, let's just say, half a percent distribution that's defined as a return to capital. That half a percent is not taxed in that current year. What it does is it reduces the cost basis that you paid for the fund by that half a percent. So when you go to sell the fund in the future, if you do sell the fund, well, now your cost basis was reduced. So you'd pay more taxes on the back end, but you're paying a long-term capital gains rate now at that point.

22:02So maybe that fund was generating short-term capital gains, which are really taxed at ordinary income for individuals. And that is now being able to be converted from a short-term capital gain into a long-term capital gain. So very tax opportunistic for an investor. So we think about return of capital actually as a very positive for investors because you're taking an income stream currently, let's say on a monthly basis, but you're taking what could have been taxed at a much higher rate, and you're able to defer it to making sure that it is a long-term capital gains rate, which is the most favorable tax rate that we could possibly be in in the country.

22:40And as we all know, I don't think anyone assumes taxes are going to go down over the next number of years, regardless of whether that's a year or 10 years or 100 years. We all know things get more expensive. So we really think about that way that that return of capital can be a great opportunity to investors to defer taxes and make sure that gets converted to a long-term capital gains rate. Garrett, Troy, thank you guys so much for hanging out with us on this episode of the Rich Habits Podcast and breaking down just how simple it is for anyone listening to begin generating their first$1 ,000 of passive income inside of their portfolios.

23:15We very much appreciate it. And I'm sure we're going to have you back here pretty soon as well. Yeah, I feel like we could spend hours just talking about short-term capital gains versus long-term capital gains and everyone understanding that because you know, all the fake gurus out there, they just don't ever cover that. They tell people to get in and out and time the market and do all these crazy strategies. And a lot of times they're just trading money because they're not taking in these short-term and long-term capital gains strategies to understand where they're at. So appreciate you guys coming.

23:45Thank you all for following along. This has been an awesome learning curve, even for me today in this episode. And we appreciate all of you that follow along the Rich Habits podcast each and every week and give us those five-star reviews. Thanks everyone. And have a great start to your week.