Dividends paid by shares are the best way I have found to date of generating passive income. This is money made with minimal effort on my part. All I need to do is pick the right shares and then occasionally monitor how they are doing.
That said, the rewards from such investments can be spectacular over time. They can provide a much better standard of living than would otherwise be enjoyed. And they can allow for a comfortable early retirement too.
A prime passive income stock?
Commodities giant Rio Tinto (LSE: RIO) has been in my core passive income portfolio for some years.
Its yield has varied over that period as this moves in opposite directions to a firm’s share price. Currently, it is giving an annual return of 6.7%. This is based on 2023’s 435 cents dividend – fixed at 341p – and the present £50.88 share price.
So, investors considering a £10,000 holding in the firm would make £670 in first-year dividends. Over 10 years on the same average yield this would rise to £6,700. And after 30 years on the same basis, this would increase to £20,100.
However, if the dividends were reinvested back into the stock – ‘dividend compounding’ — the passive income would be much higher.
Doing this on the same average 6.7% yield would generate £9,506 in dividends after 10 years, not £6,700. And after 30 years on the same basis, it would rise to £64,217 rather than £20,100.
With the £10,000 initial stake added in, the value of the Rio Tinto holding by then would be £74,217. This would pay an annual passive income of £4,973.
Making more from just £5 daily?
I think a common misconception is that a lot of start-up capital is required to generate life-changing passive income. This is not true.
Just saving the price of a cup of fancy coffee — £5 a day (£150 a month) – and investing it in Rio Tinto could make £7,824 in dividends after 10 years. This is based on the same average 6.7% yield (which is not guaranteed, of course) and dividend compounding as before.
And over 30 years on the same basis, this would increase to £120,450. Adding in the £150 a month deposits over the period and the total holding would be worth £174,600.
This would pay £11,698 a year in passive income by that point.
Is the core business healthy?
Rio Tinto’s H1 2024 results saw profit after tax jump 14% year on year to $5.808bn (£4.66bn). Underlying earnings rose 3% to $12.093bn and net cash generated from operating activities increased 1% to $7.956bn.
I think a principal risk to future earnings is renewed economic weakness in the world’s largest commodities importer, China.
However, December saw Rio Tinto underline its new strategy of investing for a stronger, more diversified and growing portfolio.
It targets major production increases in copper, iron ore, and lithium in the coming years. I think each of these should see strong demand from ongoing industrialisation and urbanisation.
And they are also likely to strongly benefit from the boom in energy transition projects in emerging and developing markets, in my view.
Consequently, if I did not already own the shares I would buy them today for their strong yield and growth prospects. I think they are worth investors considering.
