The idea of generating passive income from stocks is incredibly appealing, as it allows me to receive money without having to actively work for it. And who doesn’t want that?!
Whether I’m looking to supplement my income or create a steady flow of future earnings, the stock market offers several strategies to achieve this.
Here, I’ll explore three of them.
Immediate gratification
The first and most obvious way is to stick a lump sum into a few stocks and wait for the dividends to arrive in my investing account. Then I can spend the cash.
For example, let’s say I invest £20k (the annual ISA limit for tax-free gains) in a portfolio of five dividend stocks. If the average yield from these is 6%, then I’d expect to receive £1,200 in annual passive income.
I say ‘expect’ because individual dividends aren’t a surefire thing. Serious situations can develop — financial panics, wars, global pandemics — that force companies to cut or cancel their payouts. Firms can also run into individual difficulties.
Therefore, diversification‘s the name of the game when it comes to building a portfolio.
Fortuantely, UK investors are spoilt for choice when it comes to high-yield dividend stocks. There are nine offering yields above 6% in the FTSE 100, including banking goliath HSBC and insurer Aviva. There are a load more in the FTSE 250.
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Reinvest dividends
The second strategy could be to reinvest the cash dividends I receive rather than spend them. This is called dividend reinvestment.
For example, let’s say I have £4,000 worth of British American Tobacco shares and they pay me the current 8.5% yield. This involves a quarterly dividend of 58.8p per share, meaning I’d receive around £85 every three months (or £340 a year).
Instead of spending this, I could use it to buy more shares. Then those would ideally pay me more dividends, and so on. This would harness the power of compound interest (the wealth-building magic).
Obviously, this is a form of deferred gratification. It involves reinvesting the payments to fuel compounding for a higher potential passive income in future.
Going for growth
The third way involves trying to build up my pot more quickly by investing in high-growth businesses.
One option today could be Uber Technologies (NYSE: UBER). I recently invested in the ride-hailing and food delivery giant, whose shares are up 25% in 2024.
However, one risk I see here is the rise of autonomous vehicles (AVs or robotaxis). If these self-driving car firms build out their own consumer apps, Uber could one day be cut out as the intermediary platform.
To counter this, it has partnered with all the big AV firms, allowing them to tap into its massive 156m user base. But AVs remain a potential risk.
Still, after years of steep losses building market share, Uber’s profits are now motoring higher. In fact, analysts see earnings more than doubling over the next couple of years.
By 2026, Wall Street expects revenue of $58bn, up from $37.3bn last year. That’s high growth alright!
If my £20k portfolio made up of such stocks grows at 11% a year, I’d have £271,709 after 25 years. Then, if I switched to 6%-yielding dividend shares, I’d be receiving £16,302 a year in passive income.
