During my life, I’ve grown to love passive income — earnings other than from work or from my ‘side hustles’. However, even unearned money can take effort, patience, and time to deliver.
My favourite passive income
My life as an investor started in my teens. Being interested in maths and financial markets was a bonus, but I soon discovered that the path to riches was long and bumpy.
Over decades, I came to appreciate this wisdom from American tycoon John D Rockefeller: “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” Nowadays, a large chunk of my family’s passive income is from share dividends.
However, here are three key points about company dividends:
1. Future dividends are not guaranteed, so they can be reduced or stopped at short notice.
2. Very high dividend yields don’t always last and may be a warning sign of future problems.
3. When businesses get into trouble, dividend payouts can be the first to be sacrificed.
Despite these issues, my family collects thousands of pounds a month in cash dividends. As we don’t need this income right now, we reinvest it by buying more shares. This boosts our shareholdings and future returns. For me, this is the best ‘magic money tree’ I’ve found.
Dividend delights
How could an investor turn £5,000 in savings into a passive income exceeding £5,000 a year? The answer lies in the marvel that is compound interest.
For example, let’s say our investor spots shares in a well-run company offering a dividend yield of 10% a year. They buy £5k of this stock with their savings pot and then time will do the heavy lifting. After, say, 25 years of reinvesting cash at a return of 10% a year, the original pot will have grown to around 10.83 times its original value — in this case, £54,174.
Of course, by continuing to collect the 10% dividends on this enlarged amount, these would be around £5,417 a year. Our investor could then take this cash stream in passive income, or continue to reinvest for growth.
A FTSE 100 dividend duke
Though a quarter-century is a long time, it’s almost never too late to start investing, even at my age (57). For example, here’s one FTSE 100 share my wife and I bought for extra passive income.
Well-known UK investment manager M&G (LSE: MNG) was founded in 1931, launching Britain’s first unit trust that year. Today, this group manages money for over 5m clients worldwide. M&G listed its shares in London at 220p a share in October 2019.
As I write, this stock trades at 206.3p, valuing this business at £5bn. At this price, M&G shares deliver a dividend yield exceeding 9.7% a year, within a whisker of the hypothetical 10% yield above. This is almost 2.8 times the 3.5% yearly cash yield offered by the wider Footsie.
Fortunately, M&G has billions in spare capital, so I expect this generous payout to continue. Alas, when financial markets melt down (as they did in early April and in spring 2020) asset managers like M&G can take a beating. Market crashes can crush their revenues, earnings, and cash flow. Even so, we are happy to own this high-yielding stock for its powerful passive income!
