The secret passive income strategy I’m using to try to 3x my returns!

Investing for passive income is an important investment tool. But what if I combine the power of compounding returns to boost yields?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Passive income text with pin graph chart on business table

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

For most investors who go down the passive income route, it is no more than a way to add a little extra cash every year. This is because the average yield of the FTSE 100 is around 3.4%. And for investors working with smaller sums of cash, this amounts to little compared to the lure of investing in trending stocks that could skyrocket in a year.

We are all aware of the power of compounding returns. What if I combine the safety of passive income and the power of compounding returns to boost long-term earnings? Can this strategy help me turn my passive income into a retirement-worthy sum?

DRIP investing to boost passive income

Short for ‘dividend reinvestment plan’, DRIP investing is a less-explored style of using passive income, which could grow returns over the long-term by two or even three times (3x). The idea is simple: every time I receive a dividend payout from my investment, I reinvest it back, repurchasing shares in the same company.

This strategy allows me to increase the number of shares I hold in the company. And this, in turn, boosts my payouts every year, which allows me to repurchase a larger chunk of shares. And as I follow the Foolish investment philosophy of investing for the long term, this could vastly boost my returns if I pick the right dividend stocks.

DRIP vs normal dividend investing

Allow me to demonstrate the possible returns with the magic of mathematics. I have chosen dividend aristocrat Legal & General (LSE:LGEN), which has a current yield of 7.4% and has historically generated strong capital every year (with plans of boosting yield year on year).

I am willing to invest a £10,000 lump sum investment in the company with plans of holding it for 30 years. This would get me 4,098 shares at the current share price of 244p. I am placing the average yield of Legal & General shares at 5% (accounting for fluctuations) paid annually, with a 3% increase in yield every year and 0% share price growth.

Without DRIP investing: after 30 years 

Final investment value: £10,000 (assuming 0% share price growth) 

Final dividend income: £23,785.61 

Total investment returns: £33,785.6

With DRIP investing: after 30 years

Dividend contribution: £88,146.52

Total investment returns: £98,145.64

It is clear that, over time, this passive income strategy could yield nearly 3x more than just holding dividends. And at the end of 30 years, I would own 35,983 shares in the company.

Although I assumed a share price growth of 0%, it will fluctuate. If there is a fall in share price, the yield could go up in relation, boosting my returns. If there is share price growth, I could turn my £10,000 to £100,000 with this strategy.

Risks to consider

A passive-income strategy comes with risks, too. Any company could cut dividends if revenue is affected. And for Legal & General, economic turbulence could affect income as it operates in the finance sector. A long history of dividend growth does not guarantee future returns. And for this strategy to succeed, a steady payout is absolutely crucial.

It is clear that picking a winning passive income share is the first step. But I think by sticking to blue-chip dividend shares and being diligent, I could vastly boost the earning capacity of my portfolio using the DRIP method.

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.

Suraj Radhakrishnan has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

More on Investing Articles

Passive income text with pin graph chart on business table
Investing Articles

Yields of up to 7%! I’d consider boosting my income with these FTSE dividend stocks

The London market has some decent-looking dividend stocks right now, and I’m tempted by these two for growing income streams.

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

I’d put £20K in an ISA now to target a £1,900 monthly second income in future!

Christopher Ruane shares why he thinks a long-term approach to investing and careful selection of shares could help him build…

Read more »

Mature couple at the beach
Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »