Buying passive income shares can deliver a robust cash stream in good times and bad. I like adding to my own dividend portfolio when the stock market falls, allowing me to capitalise on higher yields. So why are so many UK share investors staying away and holding cash instead?
As I’ll hopefully prove, this could turn out to be a very expensive mistake.
Cash vs shares
One problem is that cash accounts typically deliver poorer income streams compared with share investing. Today, the best-paying Cash ISA with no notice period is offered by Trading212. Its variable interest rate is 4.51%, which isn’t terrible compared to what savers became used to in the 2010s.
But compared with the dividend yields that hundreds of stocks currently offer, that’s hardly great either. On the FTSE 100 alone, there are 16 companies with a forward yield higher than that, led by Legal & General (LSE:LGEN). The reading here is an enormous 8.8%.
Now let’s say someone has £20,000 to invest in a Cash ISA or Stocks and Shares ISA. If they opened that Trading212 account, they’d have a £902 passive income over one year, assuming the Bank of England keeps interest rates unchanged.
What about if they bought Legal & General shares in their investing ISA instead? They’d have made an income of £1,760 instead.
Let’s talk Legal & General
Dividends aren’t guaranteed. But I’m backing Legal & General to deliver the huge payouts analysts are expecting. Its asset management, insurance, and retirement divisions generate a steady flow of cash for dividends and share buybacks. As of December, its Solvency II capital ratio was 210%, soaring above the 100% regulatory minimum.
Could shareholder payouts come under pressure further out? It’s possible. Competition is mounting in key areas like pension risk transfer (PRT), which could impact earnings. Given the firm’s high payout ratios, a cut to dividends down the line isn’t out of the question.
Yet it’s highly unlikely in my view. I expect the company to maintain a strong balance sheet and enjoy solid profits growth, underpinned by demographic trends driving financial services demand.
Building retirement wealth
Now let’s talk about the second problem of prioritising cash savings.
The thing is, share investing doesn’t just offer the possibility of dividend income. With a well researched and diversified portfolio, individuals can also make juicy capital gains. This combination over time can lead to a life-changing passive income later down the road. Just ask one of the 5,070 Stocks and Shares ISA millionaires currently living in the UK today.
Let’s say that best-paying Cash ISA rate stays unchanged at 4.51% over the next 25 years. If I invested a £20,000 lump sum each year and reinvested the intererest, I would have £904,094 at the end of the period.
What about if I put that same £20k in a stocks ISA instead? Based on the long-term stock market average return of 9%, I’d have £1,792,708 with dividends reinvested. That’s almost double what I’d have made with a savings product.
And if this was then invested in 7%-yielding dividend stocks, it would generate a £125,490 annual passive income, or £2,413 a week. With many top dividend shares now trading cheaply, I think today’s a great time to explore the stock market.
