2 passive income ideas I think can help me beat inflation

As UK annual inflation hits a three-decade high, our writer shares two passive income ideas he think might help him stay on top of it.

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Preparing a budget during a pandemic

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Inflation means my income will not stretch as far as it did before. With annual inflation having soared to a near 30-year high of 5.4% last month, I have been looking for passive income ideas I can use to help beat it.

Here are two I would consider using.

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Dividend shares

I like dividend shares as passive income ideas because they allow me to earn money from the work of large, successful businesses.

But high inflation could reduce the value of dividends for me. If the dividend income I receive each year is outstripped by inflation, then the real value of my earnings will be falling. If I can find dividend shares paying out at a higher rate than inflation, I could still benefit from passive income next year, even after the impact of inflation on my spending power.

Imperial Brands

One such company is tobacco giant Imperial Brands (LSE: IMB). Its shares currently yield 8%, comfortably above the rate of inflation.

Tobacco is a highly profitable business. Imperial can use such profits to support a high dividend. Declining cigarette use in many markets could hurt revenues, although the company’s strategy is to use price increases to mitigate the impact on profit.

From a business perspective, I think inflation could help Imperial’s revenues. In an era of rapid price increases, it should be easier for the company to hike the cost of its products. That said, this will not necessarily translate into higher profits, though, if cost inputs like labour and materials also increase in price. Indeed in its final results in November, the company’s outlook warned of the “risk of inflationary pressures”. It hopes to combat them through its buying strategy, strong profit margins and pricing power.

Direct Line

Another company with a dividend yield higher than inflation is Direct Line (LSE: DLG). The insurer with the iconic red telephone logo currently yields 7.2%.

Insurance categories such as home and motor tend to have fairly predictable economics. Sometimes the cost of settling claims can vary – for example, Direct Line warned last year that rising second-hand vehicle costs could eat into profits. But over time, such costs can typically be absorbed through adjusting premiums. It is the stability and resilience of insurance that attracts me to it as an investor. In Direct Line’s case, I see the dividend as a handsome reward if I hold its shares.

Like Imperial, I reckon Direct Line can manage inflationary risks by passing on some cost increases to its customers.

My next move as inflation soars

I would consider adding Direct Line to my portfolio. I already own Imperial for its passive income appeal.

While inflation can reduce the real value of dividends to me, I am also concerned about the impact on capital I tie up in shares. If inflation is high, then a static share price would mean that my capital represents declining spending power. So while I am hunting for inflation-busting passive income ideas, I am also looking at the share price growth prospects of companies I buy for my portfolio. If a company has strong income potential but also a business outlook that can support possible share price growth, it may be more attractive to me as an investor in inflationary times.

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Christopher Ruane owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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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