For a long time, investors looking for passive income didn’t have much choice. Interest rates were below inflation, so the only way to avoid diminishing buying power was to buy dividend shares.
That isn’t the case any more – inflation has fallen to 3.2% and a 30-year government bond comes with a 4.6% yield. But I still think dividend stocks are a better choice for investors looking to generate extra cash.
Savings
According to money.co.uk, the mean average amount held in a UK savings account is £17,365. Investing that in a 30-year government bond could generate just under £800 per year in extra income.
That’s not bad, but I think it’s possible to do better. The big advantage dividend stocks have is that the amount a business pays out to its shareholders can grow over time.
Over 30 years, this can make a big difference. For example, shares in Bunzl (LSE:BNZL) come with a 2.15% dividend yield, but the company has been increasing its dividend by 7% per year over the last decade.
If this continues, someone who invests £17,635 in Bunzl stock today could potentially receive £35,272 in passive income over the next 30 years. That’s much higher than the £23,964 being offered by the bond.
Long-term income
The advantage of stocks over bonds is that their dividends can increase. But they’re not guaranteed to grow at any particular rate and there’s a much higher chance of returns going down – or being stopped entirely.
That’s an inevitable risk when it comes to dividend shares, but there are some things investors can do to try and limit the danger. The most important is having a clear view of the company’s long-term prospects.
Sticking with Bunzl, the company has increased its dividend steadily, but what about in future? One reason to be positive is that the firm has a number of acquisitions in the pipeline that should boost its revenue and profit.
Relying on this over the long term to keep growing the business could be risky as the firm’s increasing size makes opportunities harder to find. But there is another reason to think the dividend has room to increase.
Competitive advantage
Possibly the most important thing about Bunzl from an investment perspective is it has a clear advantage over its competitors. The company is in the business of distributing things like disposable tableware and carrier bags.
Customers want two main things from a distributor – speed and reliability. And the global scale of Bunzl’s operations allows it to provide both.
Operating on a large scale can have its disadvantages, though. One of the downsides to a large business is that it can be hard to focus on the specific needs of individual customers and react to them.
Bunzl, however, operates a decentralised model. This means that individual managers are able to see when customer needs change and react quickly to them without having to go through a central bureaucracy.
Dividend shares
Dividend shares are no longer the only game in town for investors seeking passive income. But I think they’re still the best choice.
If I had £17,365 to invest, I’d be looking to buy stocks. And Bunzl is one of the names that would be on my list.
