Looking for a way to diversify your portfolio outside of the mainstream financial markets? There are several ways to do so, but a growing number of people are focused on a less conventional way of passive income. Royalties. We’ll go through a complete guide on how to invest in royalty income.
The way you receive income from royalties is by owning rights to intellectual property (IP). Every time someone uses that said intellectual property, they have to pay to use it. They will be paying the royalty holder, which would be the investor who holds the rights.
The most popular royalty income streams are owning the rights to songs, but also owning the rights to a patent or brand can provide similar passive income streams.
Now let’s dive in and discover how to invest in royalty income.
What You Need to Get Started
It’s easy to start! All you need is the drive to explore another less familiar asset, and a computer. Of course, you will need some cash to start with as well.
Royalties can range from a few hundred dollars for music that isn’t mainstream to hundreds of thousands of dollars for a classic song. Making the entrance to market low for anyone who is looking to diversify.
Advantage of Having Royalties in Your Portfolio
Having a truly diversified portfolio is difficult to achieve. Even with a diversified stock portfolio, the entire market can crash and your diversified holdings can all lose substantial value. Even legendary investor Ray Dalio claims diversifying well is the most important thing you need to do in order to invest well.
Royalties offer the opportunity to be diversified away from market corrections and crashes. They are uncorrelated with other large asset classes, so you can have reliable income even during recessions.
Online Royalty Exchanges
Now that you have the cash you need to make a purchase and your computer all set up, it’s time to search the web for the right opportunity. There are a few exchanges where you can either buy royalties second-hand or directly from the source. The top two are listed below with a brief description.
Royalty Exchange
Royalty Exchange is the number one site for buying and selling royalties. The site enables you to buy royalties directly from the artist or IP owner and has been around since 2011. The two main avenues to make purchases through the site are via auctions or their online listing “eXchange”.
Royalty Exchange Auctions
Buying royalties directly from the original owner is done through live auctions and are typically priced at a pretty penny. These auctions enable you to have access to own the rights to some of the world’s most popular music and can bring substantial income.
Royalty Exchange Listings
The more affordable and abundant option is on their “eXchange”. At any given time, the site offers hundreds of different songs or IPs that they list on the site and are available to bid on.
The site offers loads of information on each listing. They cover what offers other investors have made, past 3 years’ earnings (including where these earnings came from), and even an analyst cost benchmark if you become a paying member.
SongVest
SongVest is another popular site that offers the opportunity to invest in royalties. This alternative is not quite as popular, and doesn’t offer as much of a selection as the prior site, but can be an option.
SongVest only has an auction section and not a general listing site. The packages that the site offers for auction are generally pretty pricey and well-known songs. SongVest is more for the high net worth investor willing to put a decent amount of capital into music royalties.
How to Spot Opportunities
Picking the right investment when it comes to royalties is different than other mainstream income-generating assets. Most music royalties tend to decrease in value over time as a song loses popularity. Other IPs may increase in value as certain technologies take off.
Since music royalties are the most mainstream income-generating royalty, I’ll explore a few tips on how to spot opportunities within this asset class. Let’s take a look at a few of these below.
1. High Dollar Age
Dollar Age is a metric that tracks the age of the income generated from a given portfolio of songs. The metric averages the income age of the songs in the portfolio, and shows if the revenue is coming from old or new songs.
I’ll quickly run through how to calculate this via an example:
- Listing A
- Song 1:
- 4 Years Old
- $2,000 Last 12 Months Revenue
- Song 2:
- 2 Years Old
- $2,000 Last 12 Months Revenue
- Song 1:
Since half of the income came from a song that was 4 years old and half of the revenue came from a song that was 2 years old, our Dollar Age for Listing A would be 3 Years.
If there is only one song on the listing, then the dollar age would automatically be how old that one song is.
It is challenging for songs to deliver consistent income over long periods of time. Income from royalties tends to taper off after a few years of the song being released. A high dollar age is a general indicator that the investment has limited risk. Revenues tend to be more stable and are less likely to decrease with time.
Spotting songs that have been around for ten plus years and have had stable revenue for the past two to three years can indicate this trend is anticipated to continue moving forward.
Songs with low dollar age are less reliable forms of income as popularity may taper off with time.
2. Income Tied to a Timeless Icon
Like the Fender Stratocaster, some icons are timeless. Having royalties that tie into a timeless icon or piece of work can generate the consistency we noted that is difficult to find.
Examples of this would be theme songs for classic sitcoms. As long as the re-runs are playing, you’ll be putting money in your pocket. Another example is songs from a popular deceased artist that will continue to jam on classic rock stations for years to come.
As a result of the consistent and reliable income, most of the songs in this category can be pricey. Though like any asset, there are plenty of reasons for someone to sell at attractive prices. Take the opportunity if it comes up!
3. Low Price/LTM Income Ratio
Like any great investment, the optimal way to invest in royalties is to keep your costs low relative to income. This metric is similar to the P/E ratio that is common in judging how expensive a stock is.
The price over the last twelve months (LTM) of income is a very simple formula that can be calculated as follows:
- Listing A
- LTM Income: $1000
- Price: $10,000
- Price / LTM Income = 10
Having a low P/LTM ratio indicates that you are getting high value for your money, and you aren’t paying a premium for the income the asset is producing.
Generally speaking, a ratio of less than 10 indicates that you are receiving a great deal. This indicates that you will have annual returns upwards of 10% per year.
Like other assets, this ratio is misleading if the proper homework isn’t completed. If the listing has a low dollar age, the P/LTM ratio may be low since returns are expected to dwindle. Make sure to combine this ratio with the other two tips and not solely base your investment on this ratio.
Expected Return from Royalties
We’ve learned a lot so far on how to invest in royalty income. Now you might be wondering how much money these new investments will put in your pocket.
Expected returns can vary depending on numerous factors. Though it is not uncommon for returns to average 10-12% per year in income. There might be macroeconomic circumstances that may change returns from year to year, but in general, if you thoroughly research your investment you can expect these high reliable returns.
Wrap-Up
That sums it up for our guide on how to invest in royalty income. Royalties can be a great investment, but like any asset are no walk in the park to pick. Take your time and do the right research to find a meaningful long-term income stream.
If you’re looking for a few off-the-wall investment ideas you can check out our post on Recreational Investments. Let us know in the comments if our guide was helpful!
Love the blog Jack! I’ve never explored the royalty income world, but it was eye opening that they can generate up to 10 to 12 percent! I’m definitely more comfortable with stocks, but it’s nice to know that these opportunities exist too! Keep up the great work!
Thanks! Happy you were able to learn something new!