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Of the many different ways of generating passive income, I reckon investing is one of the least demanding. After all, the UK market is chock full of companies paying chunky dividends to people like you and me just for owning a slice of their businesses.
Prime candidate
Let’s say a new investor had £20,000 ready to put to work — currently the maximum amount that can be invested in a Stocks and Shares ISA in a single year.
One candidate I suspect they might consider buying is Lloyds Bank (LSE: LLOY). And it’s not hard to see why. Right now, its shares come with a forecast dividend yield of 4.9% in the current financial year. That’s certainly not the highest in the UK market but it’s above average.
Based on these numbers, an investment of £20,000 into Lloyds would generate £980 in passive income in 2025. But those willing to put that tidy sum back into the market stand to make a lot more thanks to the magic that is compound interest.
As it happens, this is my exact strategy: owning stocks for the long term and reinvesting my dividends. This way, the amount of passive income I receive in 10 or 20 years will likely cover most of my monthly expenses. That’s the sort of financial freedom I crave!
No sure thing
There are just a few things to note.
A company’s yield will change as a result of its share price rising and falling. When the stock goes up, the yield falls and vice versa. So, that dividend yield is never really set in stone.
Any calculations made by analysts in advance should also be taken with a pinch of salt. Ultimately, the proportion of profits that shareholders receive is decided by a company’s management. And that depends on how well it’s been trading.
Speaking of which, there’s no guarantee that Lloyds — or any other company for that matter — will remain a great source of dividends. They are usually the first thing to be shelved when the going gets tough.
On a positive note, the £43bn cap is a huge player in UK retail banking. This focus arguably helps to shield it from volatility in international markets. It also goes some way to explaining why the share price is up by a third in 2025 so far.
On the other hand, this overdependence could come back to haunt it if our economy takes a tumble from here. As the UK’s largest mortgage lender, for example, the bank would be very exposed to a slowdown in the housing market.
Spread the risk
Given the above, I think it’s wise for our investor to consider spreading that £20,000 into different sorts of businesses. This still doesn’t guarantee that any specific dividend stream will be paid. But it should help to cushion the blow if one or two companies are forced to cut their distributions.
There is, of course, also nothing to stop our investor from adding new money on top of their original stake as the years pass. The more cash that goes in now, the more passive income there should be to spend guilt-free on lots of lovely things later.
