Passive income! How I make money while I sleep

Picked carefully, this Fool thinks stocks provide the best source of passive income going. They’ll even earn money while he sleeps!

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Making money while tucked up under my duvet sounds pretty good to me. Fortunately, the stock market offers what I consider to be the easiest way of doing this. 

The ultimate form of passive income

Passive income from investing takes the form of dividends — a proportion of profits paid out to owners (usually twice a year) for holding shares in a company. What effort does this require on my part? Absolutely none, aside from the initial purchase. Zip. Nada. Compared to becoming a landlord or starting a side hustle on eBay, it has arguably the best trade-off between effort and reward going. 

Obviously, there’s some effort involved. To get started with investing, I first need to find ways of cutting down my monthly expenses to free up some money. On top of this, it’s also vital to buy everything inside a Stocks and Shares ISA. This protects all of the passive income I receive from the taxman. 

Of course, I also need to select which stocks to buy. Thankfully, there’s never been a shortage of these. 

Stocks that pay me

For years, I’ve owned shares in online trading firm IG Group. This company makes its money by charging fees to clients that aim to profit from the stocks market’s inevitable ups and downs. As one might have guessed, business has been rather good lately. Right now, IG offers a yield of 5.5%. In sharp contrast, the top Cash ISA pays just 0.67%.

Another example is Somero Enterprises. It manufactures laser-guided equipment to ensure concrete surfaces in warehouses are as flat as a pancake. With retailers desperate for space to hold their products as online shopping explodes in popularity, I think this company is in something of a sweet spot.

Actually, I know it is! On Tuesday, the small-cap upgraded its full-year guidance following stellar trading in its largest market, North America. Most of that will have happened while I was asleep. At 6.3%, Somero yields even more than IG!

Of course, if I wanted to reduce my workload even more, I could ask a professional fund manager to pick stocks for me. That said, this strategy involves paying fees which ultimately reduces the amount of income I’d hang on to. There’s no guarantee a pro will do a better job either. 

Nothing is guaranteed

Naturally, there’s a caveat to all of this. Just as I can’t be assured a perfect night’s sleep, nor can I assume that the stocks I own will always be in a position to pay out. In tough times, dividends can be cut as firms attempt to shore up cash. 

I see two ways of mitigating this risk. First, own a bunch of passive income-paying stocks from different sectors. As an illustration of this, both IG Group and Somero are market leaders at what they do but operate in very different spaces. Throw in a few more stocks and this diversification should go some way to protecting me if one or two struggle. 

A slightly more involved step is to check the extent to which a company’s profits cover its dividend. Although earnings will naturally vary from year to year, this should ideally be two times. Anything lower than one and that passive income stream looks vulnerable. A consistently rising dividend is another indication of health. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers owns shares in IG Group and Somero Enterprises. The Motley Fool UK has recommended Somero Enterprises, Inc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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