Living in a university town, I’ve met hundreds of students. I really enjoy the positive energy of these young, enthusiastic and entrepreneurial folk — plus their sheer numbers lower beer prices at my local pub! I’ve met lots of youngsters with side hustles: money-making ventures to pay their way through university. As a financial ex-professional, I try to reveal the joys of passive income to them.
What is passive income?
Passive income is money I make outside of my job. This extra cash involves no extra time, effort or work from me. I remember this powerful lesson from American mega-billionaire Warren Buffett. The Oracle of Omaha once said: “If you don’t find a way to make money while you sleep, you will work until you die.”
Taking this advice, I aim to build passive income and personal wealth at the same time. To do this, I invest my spare cash into income-generating assets. But in this age of near-zero interest rates, this is tough. Cash deposits pay very low rates of interest nowadays (around 1.5% a year from top instant-access accounts). Likewise, the income paid by bonds (government and corporate fixed-income IOUs) has fallen dramatically over the past 40 years.
I buy shares for cash dividends
Therefore, my preferred way to collect passive income — and get richer — is by buying company shares. Obviously, buying shares is much riskier than saving in cash, but 35 years of experience has taught me that higher risks usually mean higher returns.
When I buy shares in large, solid UK companies, I become part-owner of those businesses. And if they do well, so do I — because share prices tend to rise over time. But I don’t just invest in any old companies. I much prefer to buy stocks that pay generous dividends to shareholders. I rely on this stream of passive income to build wealth over time.
Dividends are cash payments paid by companies to their shareholders. Typically, these payments are made half-yearly or quarterly. However, company dividends are not guaranteed, so they can be cut or cancelled without notice. This happened a lot during 2020’s Covid-19 crisis. But not all UK-listed companies pay dividends to their shareholders. In fact, the majority don’t provide this passive income to their owners. Why not? Well, these firms may be loss-making, or choose to reinvest profits to boost future growth.
However, roughly 90 of the 100 shares in the FTSE 100 index pay dividends to their shareholders. Right now, the Footsie offers a dividend yield of roughly 4% a year. But I prefer to buy higher-yielding dividend shares — those with market-beating cash payouts. I can then spend this passive income, or reinvest it to boost my future profits by buying yet more shares.
My bonus kicker: capital gains
Finally, owning shares does much more than provide me with passive income. When share prices go up (they also go down), my portfolio becomes more valuable. Occasionally, I take profits by selling shares that have gained in value. I then reinvest these profits into more stocks, or use these lump sums to fund major purchases.
In summary, I’ve yet to discover a better side hustle than owning shares for passive income and capital gains. Even better, these returns are tax-free inside a Stocks and Shares ISA!
