In over 23 years as a financial writer, I’ve written so much about passive income. But what is it? Simple: passive income comes from sources other than paid work.
Unearned income
For example, popular sources of passive income include:
1. savings interest (from cash deposits with banks and building societies)
2. rental income from property (by being a buy-to-let landlord)
3. coupons (interest payments) from bonds (debt securities issued by governments and companies)
4. pensions (retirement income from personal, company and state retirement plans)
That said, I’m not that keen on options one and two. First, because I don’t know anyone who got rich purely from saving in cash. Second, because being a landlord looks like hard work.
For me, the best source of passive income is dividend-paying shares. But what are they?
Delicious dividends
Dividends are regular (or one-off) payments made by some companies to their shareholders (owners). However, dividend investment is not a guaranteed route to riches, for several reasons.
First, future dividends are not guaranteed, so they can be cut or cancelled at short notice. Second, not all companies pay dividends. Some businesses are loss-making, while others prefer to reinvest profits to boost future growth. Third, most UK-listed stocks don’t pay dividends, though most FTSE 100 shares do.
A FTSE 100 flood of cash
One stock my family portfolio owns for powerful passive income is Legal & General Group (LSE: LGEN). This well-known insurer and investment manager has looked after other people’s money since 1836. After 190 years, it manages over £1.2trn of assets for millions of individual and institutional investors.
As I write, L&G shares trade at 264.1p, valuing this storied group at £14.8bn. At this price, the stock offers a bumper dividend yield of 8.3% a year. That’s heading for triple the wider FTSE 100’s yearly cash yield of around 3.1%.
Then again, paying out market-beating dividends can prove a problem. These payouts ought to be covered by cash flows and reserves — thus, excessive payouts can depress share prices. Over one year, L&G shares are up 9.1%, but they have slipped 6.8% over five years (excluding dividends).
Happily, L&G has billions of pounds of spare cash on its balance sheet. Also, its yearly dividend has risen every year since 2015 — except during the Covid-19 crisis, when 2020’s payout was the same as 2019’s.
Of course, this group’s fortunes are closely tied to the health of financial markets. Hence, the next time stock and bond markets tumble, I’d expect L&G’s profits to follow suit. Also, the relentless push of giant US asset managers into European markets is putting fund fees under sustained pressure.
Finally, I can’t tell you which shares to buy, but we’ve been happy owners of L&G stock since mid-2022. For nearly four years, we have collected our juicy dividends and then reinvested them into more shares. And until this dividend dynamo stumbles, we will hold on tightly to our stake in L&G.
PS: There are rumours that L&G is being stalked by potential suitors, including its huge American rivals! To find out which other stocks are moving markets, read on…
