Putting money to work in the stock market is a fantastic way to establish a passive income stream in the long run. But for prudent savers who’ve built a substantial pile of cash savings, unlocking a big second income can be done overnight.
Obviously, having £150,000 sitting in the bank isn’t a luxury everyone in Britain has. In fact, a recent survey by Finder discovered that the average savings account for 55+ year-olds is only £27,949. However, a study by Kantar Media has estimated that around 9% of adults in the UK (roughly 4.9m people) have savings in excess of £100,000.
So let’s explore how these six-figure savings can be transformed into £11,250 of passive income.
Leveraging index funds
Right now, the FTSE 100 sits at an average dividend yield of 3.5%. And thanks to the invention of low-cost index tracker funds, replicating this yield can be done in a single transaction. Apart from achieving instant diversification across Britain’s 100 largest publicly-traded companies, a £150,000 investment would immediately start generating a £5,250 passive income.
What’s more, historically, the FTSE 100’s proven to be a relatively stable index. When compared against the likes of the higher growth FTSE 250 or tech-heavy S&P 500, the UK’s flagship companies have endured significantly lower levels of volatility as well as superior dividend stability. Needless to say, that’s an attractive attribute for investors with lower levels of risk tolerance.
Venturing beyond index investing
Despite the advantages of index investing, it does have notable drawbacks, especially when it comes to opportunity cost. A 3.5% yield pales in comparison to some of the offerings from individual stocks within the index. For example, British American Tobacco’s (LSE:BATS) currently yielding more than double at 7.5%. And at this rate, a £150,000 investment equates to a £11,250 instant passive income stream. We have to remember, of course, that it isn’t guaranteed to always generate that amount.
Ignoring any potential ESG concerns of investing in a tobacco business, there’s a lot to like about this enterprise. Most notable is the firm’s tremendous track record of hiking shareholder payouts for 27 years in a row. At the same time, the global presence of its brands helps generate a diversified revenue stream while commanding a loyal customer base.
Of course, no business is risk-free. And in the case of British American Tobacco, there’s the increasingly hostile regulatory environment to consider. Through a combination of increasingly stricter regulations paired with rising health awareness, the global smoking rate has been gradually falling. For reference, the World Health Organisation estimates 22.3% of the world’s population smoke as of 2020 compared to 34.1% in 2000. And this downward trend has continued since.
The tobacco industry isn’t blind to this trend. Price hikes have helped offset the impact and maintain cash flows to expand and sustain dividends. But in the long run, companies like British American Tobacco are looking to healthier smoking-alternative products to secure their future.
Whether these will be capable of replacing lost tobacco cash flows is a risk that investors must weigh carefully. But with a track record of defying expectations, this business might be worth a closer look by those seeking to transform their savings into a passive income stream.
