Fancy earning passive income while you sleep? There are various ways investors can approach this goal, from owning buy-to-let properties to parking cash in a high-yield savings account. Personally, I invest in the stock market.
But, even stock market investing is multi-faceted. With multiple different strategies and investment opportunities, it can be difficult to work out what the best approach is.
So, let’s explore three ways investors can aim for passive income.
1. Dividend stocks
Buying individual shares could be an attractive option. But, when investing for passive income, not all stocks are equal.
For instance, some popular companies, such as Amazon and Tesla, don’t pay dividends. Although these firms can deliver returns via share price appreciation, there are no cash payouts on offer.
Accordingly, to earn a second income, investors need to focus their search on dividend shares. Fortunately, there are plenty of stocks with attractive yields.
It’s important to look beyond the headline yield figure to ascertain how reliable a company’s dividend is. The coverage ratio and distribution history are popular indicators investors can weigh up in their investment decisions.
Regarding my portfolio, examples of FTSE 100 and S&P 500 dividend stocks I own include:
- British American Tobacco — 8.8% yield
- Diageo — 2.4% yield
- McDonald’s — 2.1% yield
2. REITs
Some passive income investors might prefer to have real estate exposure in their portfolios. But, being a landlord might not seem passive when you have a tenant on the phone complaining about a broken boiler. Well, there’s an easy solution to this.
Real estate investment trusts (REITs) provide a handy way to invest in income-producing properties. It’s important to conduct research as each REIT can have a particular sector specialism, such as retail, healthcare, or residential.
REITs also allow real estate investors to avoid costly taxes like stamp duty. Examples of REITs that investors may wish to consider include Target Healthcare REIT, which offers an 8.5% yield, and the residential-focussed PRS REIT, which sports a 5.6% yield.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
3. ETFs
Finally, exchange-traded funds (ETFs) can provide a convenient way for dividend investors to gain portfolio diversification.
Spreading stock market exposure across different companies and sectors is an important strategy to manage volatility risk. Investing in an ETF can be a good way to cover dozens, hundreds, or even thousands of stocks via a single portfolio holding.
Popular dividend ETFs include the SPDR S&P UK Dividend Aristocrats UCITS ETF, which focuses on some of Britain’s top dividend shares — or, for investors seeking global exposure, the Vanguard FTSE All-World High Dividend Yield UCITS ETF might be a good option. They yield 4.5% and 3.4% respectively.
Earning passive income
Earning £500 in monthly passive income could take as little as £120,000 invested if an investor secured a 5% yield across their holdings. That would meet the required £6,000 annual dividend target.
Building a portfolio of this size will take time. How long depends on the contributions an investor can afford and the compound annual growth rate on their collective stock market positions.
Whatever the chosen approach, investors should remember payouts aren’t guaranteed and the value of their portfolios can fluctuate. Nonetheless, despite the risks, any of the above investment strategies could be an excellent way to earn passive income.
