Passive income is unearned income. Imagine that. Instead of labouring away to be paid by the hour or salaried, money simply drops into an account ‘on its own’.
Of course, to get passive income, we usually must give something in the first place. And the thing we give is often an investment of either time or money. For example, you could write a book and collect the royalties when it’s published. Or maybe songwriting is your thing. Perhaps you’re a genius who keeps inventing and patenting things such as the ubiquitous cat’s eyes for roads, or barrows with a big ball instead of wheels.
Passive income from stocks and shares
People have made fortunes in passive income doing things like that. But, for me, the best route to passive income is the process of investing in stocks and shares. The great thing about many stock market investments is their potential to pay shareholder dividends. And those dividends tend to arrive as passive income year after year, without us doing anything else.
Sounds great, right? And it is. But before diving in, it’s worth remembering a couple of points. And the first is that companies don’t have to pay dividends. In fact, they sometimes don’t.
Company directors have complete control over whether or not to pay dividends to shareholders. And in uncertain times, they may decide to trim the level of dividends, or stop them altogether. For example, we saw a lot of stalled dividends when the pandemic hit the markets a couple of years ago. However, in many cases, dividends have since restarted.
The second point is that share prices can move down as well as up. And that means we could see an investment decline. For example, I could invest, say £2,000, in shares only to look at my account six months later and see just £1,500. However, the volatility of stocks isn’t always reflected in its dividend record. Often dividend streams continue or even grow while share prices remain weak.
The potential of shares
A third point is that as well as the possibility of shrinking dividend streams and falling share prices, the reverse is true. Dividends can increase year after year and share prices can rise at the same time. And the double effect can lead to growing passive income and a rising investment value over time.
So the important takeaway is that investing in shares leads to dynamic outcomes with risks as well as positive potential. And in that sense, the activity is unlike putting money in a cash savings account where outcomes tend to be steady but underwhelming.
However, I’d embrace the risks of share ownership by investing £15 a week into shares and share-backed investments such as funds. And in an effort to mitigate some of the risks, I’d aim to target quality underlying businesses with decent opportunities for growth. And I’d diversify my investments between several stocks.
