It’s somewhat of a buzzword in recent times. Passive income. Making money with little to no ongoing effort. Though the term is pretty new, the concept is not. Indeed, dividend investors have been doing this for decades.
Passive income covers a broad range of possible methods, from starting your own company to owning intellectual property. However, I think one of the easiest ways for individuals to begin is with the stock market. In these troubled times, the opportunity may just be perfect.
Passive income in the stock market
When talking about shares, passive income comes in the form of dividends. These are a share of a company’s profits paid out to investors. Not all companies offer dividends, and each has different payouts.
Unlike other savings and securities methods, like bonds, dividends are paid out in pence (or cents) per share. For example, a company may offer you 10p a year, in four instalments, for every share you own. This leads to an interesting and useful trait; the return you make, assuming everything else stays the same, is effectively based on the share price at which you buy the stock.
This means that the same stock paying out 10p per share would offer a return of 5% if it cost £2 per share, or 10% if it cost just £1. Though there is of course a correlation between a share price and the profit a company is making, this is often a surprising connection for those not used to investing.
Instead, expectations generally drive a share price, and expectations are often wrong. What’s more, often share prices are driven by the emotions of fear and greed rather than underlying fundamentals. This all means that with good advice or analysis, you can pick up a stock cheap. These cheap shares will offer you a better return.
Too good to be true?
Of course, it’s not quite this simple. Firstly, picking the shares that are undervalued is difficult. Experts spend decades doing nothing else and still get it wrong. That said, with some common sense and the appropriate resources, good stocks can be found.
In addition, best practices such as diversifying your portfolio or focusing on large, blue-chip stocks can also help offset the risk. There will always be some risk, however.
Another problem is that dividends are not fixed. A company can change how much it pays out at any given period if it needs to. This is usually when costs need to be cut due to poor conditions.
This is a trend we are seeing due to the coronavirus, though again, good picks can still be found. It is also worth considering a company’s payout history and consistency. A firm may be offering you a 10% yield today, but if it has been unable to pay dividends consistently, how sustainable is it?
Despite these risks, however, getting passive income through the stock market is easier than many other methods. With good advice and common sense, you could start making passive income in no time.