Earning passive income for life sounds pretty good to me. Unfortunately, there are very few ways of earning money by doing virtually nothing or without some big upfront costs (I’m looking at you, buy-to-let).
Fortunately, there is one big exception: the stock market!
How passive income works
Passive income by way of the stock market is delivered through dividends. These are, quite simply, a portion of the profits earned by the company over a period of time. They are distributed to owners of the company’s shares, usually twice a year.
The great thing about this arrangement is that I don’t need a huge outlay in order to get started. In fact, saving £100 a month is easily enough. This would give me £1,200 per year to invest.
No risk? No chance!
You’ve heard the expression that there’s no such thing as a free lunch? Well, that still applies here.
There is always a risk when it comes to investing my money. The specific risk here is that those dividends don’t get paid. This could happen in the event that a company doesn’t perform as well as it should and management is forced to conserve cash.
This isn’t as uncommon as you might think. Back in 2020, a huge number of firms cut their payouts in reaction to the unfolding Covid-19 crisis.
Thankfully, there are several ways of mitigating the harm caused.
No sweat
First, it’s important to take a long-term perspective. One upside of this is that I don’t need to watch share prices like a hawk. So long as I’ve given myself the best possible chance by selecting quality stocks with great records of delivering passive income, I can sit back.
Another (additional) solution is to diversify. This means owning shares in different sorts of businesses. This should protect me if one or two sectors (e.g., housebuilding, banking) go through rough patches and are forced to slash their dividends.
But wouldn’t buying more stocks also mean paying more in fees? Yes. This is why I’d give serious consideration to buying an exchange-traded fund (ETF) instead. These spread my money around hundreds or thousands of stocks with a single click of the mouse.
They also pay dividends. A FTSE 100 tracker like this, for example, generates a yield of roughly 3.7% right now. And unless the sky falls on our heads, it should go on paying me income for the rest of my life!
Side hustle
Not becoming dependent on the passive income generated by the shares I own is also important. In other words, I’d regard it as something to complement whatever I make from my regular day job. A side hustle, if you will.
Seeing the dividends from this perspective acts as a psychological nudge to then re-invest what I receive. Such a Foolish move allows me to benefit more from compounding. This is the secret sauce that can transform a small bit of money into a great nest egg, eventually.
Just get started
Placing £100 aside each month might be asking a lot given the rise in the cost of living. It also won’t make me rich overnight. But every installment should increase the amount of passive income I receive.
And if I could increase that monthly £100 once inflation has calmed down, the benefits just multiply!
