I’m all about the passive income. I like this way of making my money work for me, using my savings in a Stocks and Shares ISA to build an income stream.
Two popular ways to earn passive income are through a Cash ISA or a buy-to-let. Both their virtues but their drawbacks too. And if I was looking to earn the biggest passive income I could, I wouldn’t choose either.
A Cash ISA is undeniably more tempting than recent years. Some accounts are now offering as much as 6%. So each year, I’d get back £60 on every £1,000 I invest. That’s not bad.
But Cash ISAs are tied to interest rates. The Bank of England has rates set at 5.25% today so banks can borrow at 5.25% and offer customers like me a return there or thereabouts.
Yet rates are at their highest level for 15 years to help bring down inflation. Once inflation eases, rates will be lowered.
Less risky
The Bank of England’s target for interest rates is 2% and some experts predict it will get there by 2024. So I’d only get £20 a year back on every £1,000 I invest. I wouldn’t call a Cash ISA a good bet for the long term then.
I feel the same way about a buy-to-let. With an average rental UK yield of 3.63%, I’m not too impressed by getting around £36 on every £1,000 invested. Yes, I’ll have a property that could rise in value, but I think I can do a lot better for passive income.
Let’s say I want the biggest passive income possible, what would I do instead? Well, I’d look towards a Stocks and Shares ISA. Here, the passive income potential is much higher. Many investors aim for a 10% average yearly return. So that would be £100 back on a £1,000 stake. That sounds decent all on its own.
Building a passive income
The real beauty here comes from reinvesting the returns. If I take the £100 and put it back in to shares via my Stocks and Shares ISA, I now have £1,100 as a stake. I’d get £110 back as passive income the next year based on the same percentage return.
It keeps building like this. By the 25th year, my £1,000 has potentially turned into £10,835. Now, the average 10% passive income would be £1,084 the next year. That’s more than I put in and can grow even further from there. This is why so many see stocks as the best way to build wealth and a passive income.
Now, I’ll mention that I did simplify things here. In practice, it’s not a straight 10% return because stocks are volatile. the FTSE 100 for example, returned 12.5%, -14.3%, 14.3% and 0.9% in the last four years. These ups and downs are par for the course with this type of investing.
Still, compared to the alternatives, I think investing in stocks is my best chance of earning meaty passive income. I’ll continue to look for high quality stocks for my Stocks and Shares ISA.
