With interest rates at their highest levels since 2008, passive income opportunities are unusually good at the moment. And getting started has never been easier.
In my view, dividend stocks are one of the best sources of passive income. With £500, an investor like me could make a decent start on a passive income journey.
How to create passive income
One of the best ways of earning extra income is by owning a business. And there are a couple of ways of doing this.
The first involves setting up by myself, designing my own product or service, marketing it, and delivering it. It’s possible to have success this way, but there are downsides.
Starting a business from scratch takes a lot of time, effort, and money. Tough competition also means around 65% of new businesses fail within the first 10 years.
The second way is by investing in the stock market. This allows people like me to own shares in some of the biggest and best companies in the world.
Rather than setting up and competing with the likes of Apple, Coca-Cola, or Tesco, I can own part of those businesses. And in doing so, I can take a share of the profits.
This allows me to bypass the cost and effort of setting up by myself. All I have to do is buy shares and wait for my share of the profits to be distributed as dividends.
Which stocks are best?
Not all companies distribute their income to investors, though. Some reinvest their profits, with the aim of making even more money in future.
There’s nothing wrong with that. But as an investor looking for passive income, I’d buy shares in businesses that are likely to distribute their cash as dividends.
Companies pay dividends to shareholders for a couple of reasons. One is that they have no internal use for the profits they generate and the other is they have to.
Diageo, for example, uses its cash to fund its manufacturing, marketing, and raw materials. If it earns more than it needs, it returns the excess to shareholders.
Warehouse REIT, on the other hand, is a real estate investment trust (REIT). As such, it is required by law to distribute 90% of its taxable income to shareholders.
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.
Either type of business can be a fine choice. But it’s important to be aware that there are strengths and weaknesses for various individual stocks.
Getting started
With £500 I think it’s a good idea to invest in more than one business. That helps reduce the risk to a portfolio of a problem with any one of them.
Diageo’s strong brands have allowed it to raise prices and increase its dividend steadily. But this ability isn’t limitless and inflation cutting into the company’s margins is a risk.
By contrast, the requirement that Warehouse REIT distribute its earnings limits its growth. But with a dividend yield close to 8%, the starting return is much higher.
If I were starting investing today, these two stocks would be ones I’d seriously consider buying. I think £250 in each would be a great start.
