Forget cash savings. I’ll stick to buying dividend shares for passive income

Cash savings rates are finally on the up. However, our writer would prefer to take on a bit more risk for potentially higher rewards.

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.

UK money in a Jar on a background

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.

In recent months, we’ve seen the interest rates offered by cash savings accounts rise. As good as this is for anyone with money in the bank, I’d still prioritise buying dividend shares for the passive income they give off.

Cash ain’t trash…

Let me be clear. By saying I prefer dividends over cash, I’m not ignoring the benefits that come from having some of the latter.

Put simply, cash offers a degree of security that other assets can’t. When I go to bed at night, I can be sure that the amount in my savings account will look identical to what it was the night before.

This fact is deeply reassuring given the tricky economic times we live in. Should an unexpected bill arrive on my door mat today, a cash buffer will allow me to pay it. That’s why I’d never think of investing a penny if I didn’t have a few months of expenses already in place.

Notwithstanding this, it’s also a fact that any money left in the bank will still struggle to retain its value, due to rampant inflation.

Sure, the recent cap on energy bills announced by Liz Truss will help to reduce the damage somewhat. However, I don’t think we’re about to see that all-important number fall down to the Bank of England’s targeted 2% in a hurry.

This means even the best-paying savings account — currently offering 2.5% — isn’t all that great in the grand scheme of things. It’s fine for an ’emergency pot’ but that’s about it.

Fortunately, this is where dividend shares come in.

… but dividend shares could make me richer

Right now, it’s pretty easy to find stocks returning twice or three times as much as a savings account. Some companies have forecast dividend yields even higher than this! At the time of writing, housebuilder Persimmon and mining firm Rio Tinto boast double-digit cash returns.

It gets better. Assuming I already have that emergency cash fund in place, the passive income I receive can then be reinvested back into the market at a time when many companies are trading a lot lower than they once were. Theoretically, the more shares I accumulate, the more passive income I should receive over time.

Stretched out over many years and thanks to compounding, it’s not hard to imagine how this virtuous cycle could lead to a large nest egg and perhaps early retirement.

Risky business

Despite their greater appeal to Fools like me over holding cash, dividend shares aren’t devoid of risk. Companies can and occasionally do pull their returns to investors if trading is suffering. In fact, we could see this happen more and more frequently in the months ahead as a recession takes hold.

Even if most companies don’t cut, their share prices could continue falling. So I could still be registering a capital loss on paper for a while, regardless of any income I receive.

This is why it makes sense for me to have a bunch of stocks generating passive income rather than just one or two. Moreover, these should come from multiple sectors. It’s incredibly risky to buy stocks in, say, housebuilding firms and nothing else because I’m reliant on just one sector’s performance.

And that’s just not the Foolish way.

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.

Paul Summers 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

Investing Articles

Up 23% in a month, can this FTSE 100 stock continue to soar?

Airtel Africa's recently been the FTSE 100’s top-performing stock. With huge opportunities for growth ahead, is it set to continue?

Read more »

Investing Articles

£20,000 in savings? Here’s how an investor could use it to target an eventual £980 of passive income each month

Our writer demonstrates how an investor could aim to earn close to £1,000 each month in passive income from a…

Read more »

The flag of the United States of America flying in front of the Capitol building
Investing Articles

£10,000 invested in the S&P 500 at the start of 2025 is now worth…

Since the start of the year, the S&P 500's underperformed the FTSE 100. And Stephen Wright thinks investing in the…

Read more »

Investing Articles

Is this a turning point for the Diageo share price?

The Diageo share price is at an eight-year low. Is this FTSE 100 favourite simply too cheap to ignore? Roland…

Read more »

Investing Articles

As the FTSE 100 hits record highs, should I sell my shares and buy an index fund?

Our writer’s portfolio lagged the FTSE 100 last year, but he’s not giving up on stock-picking and highlights a recent…

Read more »

Happy young plus size woman sitting at kitchen table and watching tv series on tablet computer
Investing Articles

£10,000 invested in Lloyds shares 6 months ago is now worth…

Lloyds shares have performed well over 12 months but have broadly disappointed investors over the long run. Dr James Fox…

Read more »

Investing Articles

£20,000 in savings? Here’s how investors can aim for a £4,000 monthly second income

Millions of investors use the Stocks and Shares ISA as a vehicle to build wealth and generate a second income.…

Read more »

Investing Articles

This British wine-producing penny stock might just be vastly undervalued

This penny stock's certainly regained my interest. It's slumped and appears to be trading only at a modest premium to…

Read more »