I’m a big fan of keeping cash on hand to fend off any emergencies. But right now looks to me like a good time to be putting excess cash to work in earning passive income.
Interest rates are fairly high at the moment. I’m not sure how long this is going to last though, and there are dividend stocks I think can offer much more durable returns.
Inflation vs GDP
It looks like the Bank of England (BoE) is facing a dilemma. Ideally, the central bank would like inflation to come down to around 2% without the UK going into recession – but the economy isn’t playing ball at the moment.
The most recent inflation reading came in at 4%, up from 3.9%. That’s hardly a big lift, but it’s a move in the wrong direction, which has caused investors to revise their expectations of imminent interest rate cuts.
This has caused share prices to fall – and dividend yields to rise. And some have now reached a point where I think they might be underestimating the likelihood of lower interest rates.
UK GDP has been trending lower since the start of 2023 though. So with inflation staying around the 4% mark, I wouldn’t rule out the BoE having to cut rates sooner than it would like in order to avoid a recession.
If this happens, I would expect share prices to go up and dividend yields to go down. So I’m looking to strike now, while I think there’s an opportunity to lock in passive income returns for the long term.
Dividend stocks
With the recent drop in share prices, I think there are some dividend stocks with attractive yields at the moment. A good example are the preferred shares in Aviva (LSE:AV.B).
At today’s prices, the stock comes with a 6.5% dividend yield. And as a preferred stock, it has a bit less risk than most common shares.
This is because preferred dividends have to be paid in full before any common equity dividends can be paid. That means Aviva could cut its dividend entirely, but not pay common shareholders without also paying preferred ones.
The downside to this kind of stock is that the payment won’t go up. So an £11,000 investment would return £715 in the first year and the same again in year 10.
Overall, I think Aviva preferred shares right now are offering a 6.5% annual return with less than average risk. So I wouldn’t be looking to accept anything less than that from dividend stocks over the next decade.
Finding stocks to buy
There are some dividend stocks I think can probably achieve that rate of return, such as Dividend Aristocrat Primary Health Properties. And there are other cases – like Diageo – where I think it’s going to be close.
Reinvesting the distributions at a 6.5% annual return though, could turn £11,000 today into something that distributes £1,260 a year – or £105 a month – after a decade. And that looks like a decent return to me.
Keeping cash in savings looks attractive with interest rates high. But I think for investors looking for long-term passive income, dividend stocks look like a much more promising investment.
