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Motley Fool UK readers may know that I’m a big fan of passive income — earnings that come other than from paid work. American tycoon and philanthropist Warren Buffett once remarked, “If you don’t find a way to make money while you sleep, you will work until you die”. I like an easy life, so I’m very much in favour of making money with little effort.
My favourite income
There are many ways to generate passive income. The least risky is to earn interest from cash savings accounts. Currently, these pay around 4% a year before tax. Still, I know no-one who got rich solely from cash.
Another option is buying bonds: debts issued by governments and companies. While riskier than cash, diversified bond funds can produce income of 6% a year. That’s fine, but my family portfolio owns few bonds.
My favourite mainstream investment is buying shares. These are not lottery tickets; they are part-ownership of businesses. When the businesses I own do well, so do I. When share prices rise, I make money from capital gains. Also, I love collecting dividends — cash payouts made by some companies to shareholders.
I love shares and dividends
Another benefit of owning shares is that hundreds of millions of people around the world work for me and my family. Our portfolio includes many of the world’s biggest businesses in tech, finance, natural resources, consumer goods, and so on. When companies’ earnings increase over time, their share prices usually follow.
Now for a bit of financial projection. Say a hypothetical share portfolio returns 8% a year over 30 years from rising share prices and ongoing dividends. How might this compare to saving in cash or buying bonds?
My calculator reveals that investing £100 a week — for ease, I’ll make it £400 a month — over 30 years could generate these pots:
| Monthly contribution of £400 | Pot values | Growth |
| Total invested over 30 years | £144,000 | – |
| Cash at 4% a year | £275,005 | £131,005 |
| Bonds at 6% a year | £391,702 | £247,702 |
| Shares at 8% a year | £567,045 | £423,045 |
The pot from investing in shares is over twice that from saving in cash, for the same total outlay of £144,000. Eureka!
A dividend dynamo
Now, how to turn that £567,045 into income? What about buying shares in top dividend payer Legal & General Group (LSE: LGEN)? L&G is one of the UK’s leading providers of insurance, protection, and investments. Founded in 1836, this storied British business now manages roughly £1.1trn of other people’s money.
At present, the L&G share price stands at 257.7p, valuing this group at £14.7bn and making it a stalwart of the blue-chip FTSE 100 index. Over one year, this stock is up 13.4%, while it is 14.3% ahead over five years.
The above returns exclude L&G’s dividends — its current cash yield is 8.3% a year. Furthermore, L&G has billions of pounds of spare capital to support future dividends and share buybacks. Then again, if markets crash, as they did in spring 2020, then L&G’s earnings could slump.
Investing that £567,045 pot solely into this stock would deliver £47,065 in yearly passive income. However, this is highly risky, as future dividends are not guaranteed. Also, no-one should ever ‘bet the farm’ on a single share or even a handful. I much prefer to spread my risk around!
