Earning passive income from investments can be terrific. And there are lots of different assets that can provide this, including bonds, preferred shares, and dividend stocks.
What’s best for someone approaching retirement age in the next decade may well be different from what suits someone just starting work. And that’s important when it comes to considering stocks to buy.
Stocks vs bonds
If I were looking to retire in the next year, I’d aim for consistent, reliable income. In this case, I’d probably think carefully about buying bonds or preferred shares instead of common stocks.
With retirement imminent, I’d be wary of the risk of a company cutting its dividend. Even with the most consistent businesses, this is always a possibility.
Technically, there’s also this risk with bonds – a company, or even a government, might default on its debt obligations. But the chance of this happening is lower than the risk of a dividend cut.
With a bit more time until retirement, I’d look to focus on dividend stocks instead of bonds. The reason is that income from dividends can go up as well as down.
Time horizons
Exactly which stocks I might buy would depend on how long I had to retirement. The less time, the more I’d prioritise cash today over the potential for growth in the future.
For example, if I had a 15-year time horizon, I might consider Diploma. The stock has a dividend yield of 1.58%, but it’s growing at 13% a year and could be paying out a lot by 2039.
That wouldn’t be much use if I were looking to retire in five years though. In that situation, I’d need something was going to be able to generate significant income for me much more quickly.
In that situation, I might consider something like Unilever. The dividend’s only growing at 5% a year, but it comes with a current yield of just under 4% offering a much greater immediate return.
A FTSE 100 dividend stock
With 10 years to go, I’d look to balance both approaches. I’d want something that had scope for future growth, but also a decent starting yield – something like Diageo (LSE:DGE).
Diageo’s category-leading brands allow it to keep generating income even when things are tough in the economy. And the company is exposed to what looks like a solid growth trend going forward.
The shift to more premium alcoholic drinks is one that I think will prove durable. And that should help the business keep increasing its revenues and profits, leading to good returns for shareholders.
After a 22% decline in the stock over the last 12 months, there’s a dividend with a yield of just under 3% on offer. That’s a decent starting point for an investor with 10 years left to wait.
Risks and rewards
Diageo offers a nice combination of future opportunity and a decent starting yield. But there are important risks, including the possibility of higher alcohol taxes and consumers trading down.
Overall though, this is the type of stock I’d look to invest in with a decade to retirement. I see it as a durable business that will be able to grow steadily from this point on.
