Passive income is something all of us want to achieve. Being able to make money without having to break a sweat is a wonderful thing. It allows you to spend your time doing what you actually want to do instead of working. Two popular avenues to do this are via a buy-to-let property investment, or buying high-yielding dividend stocks.
First let’s define both terms. A buy-to-let property is one that you invest in purely with the aim of generating income from renting it out. A high-dividend-yield stock is one which pays out income via a dividend to the owner of the stock. The term ‘high’ is quite vague, but we will use it to refer to anything above the FTSE 100 average yield (4.9%).
Buy-to-let needs BIG funding
The first point I would flag up for income investors is the large difference in initial investment needed. To invest in the stock market, there is no such thing as a minimum investment amount. Sure, if you are paying a broker a fee then it makes sense to buy a large enough amount to make it worthwhile. But there is no hurdle to jump over. This makes investing in stocks to get dividend income attractive for a larger audience.
Buying a property for income has a much higher cost. Not only will you struggle to buy a property for less than £50,000 (or six-figure sums in most towns), but you also have other costs. These all eat into the income you are hoping to receive from renting.
Certainty of dividends
When buying a stock specifically for income, you can be fairly confident of receiving it. You can look at previous years and see how regularly dividends have been paid. Even with the recent Covid-19 pandemic, some companies are continuing to pay dividends. So if enough homework is done, you can invest with confidence in receiving such a dividend. Not only this, but you could have the added bonus of gaining from the share price increase. This would be the case if the stock market recovers later this year.
For buy-to-let, income is certain if you have tenants in the property. But what if you can’t find tenants? Or what if the property sits empty for a period of time in between tenants? These all diminish your passive income. They also reduce your investment yield.
Using the two above reasons, I would look to high-dividend-yield stocks above all in order to make passive income. As the yield is measured by the share price relative to the dividend per share, the recent sell-off has helped boost this. You can fairly easily find FTSE 100 firms that have a yield above 4.9%.
My colleague Harvey Jones flagged up a good example, Anglo American, here. The stocks currently offers a dividend yield of 5.5%. Yet it also has dividend cover of 2.49. This latter figure is the amount of times the dividend is covered by its last earnings. Anything above 2 is a good indication that the company has enough funds to pay out.
So for any spare funds I have, I am steering clear of a buy-to-let property, and remaining focused on stocks.
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Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.