Ever since Tim Ferriss’ Four Hour Work Week was published, many of its readers have wanted to start earning passive income. But I don’t think setting up a side hustle, finding suppliers and customers then dealing with the daily practicalities is passive at all. Instead, I put some money aside regularly in a Stocks and Shares ISA. By choosing quality companies with regular payouts, I can earn income with just a few minutes’ reading each week.
I’d buy a company that could survive bad management
Many investors focus on the personality cult of leaders like Tesla‘s Elon Musk. Instead, investor Warren Buffett has a long-term perspective on investing that transcends the current management or market conditions. Buffett says that it’s best to buy a company that could survive being run by idiots – because sooner or later it will be.Â
For passive income, that matters to me because it allows me to invest money without feeling the need to check on the company’s performance too much afterwards. So, for example, I’ve been watching the turnaround plan at consumer goods manufacturer McBride with interest, but I’m not clear whether it’s likely to lead to reliable dividends in the long term. By contrast, Dove and Hellmann’s maker Unilever is the sort of company I could tuck away for several decades without thinking too much about its performance. I would simply expect a dividend to arrive every quarter.
Passive income relies on a company earning money
It’s easy to feel bamboozled with talk of dividend coverage and complicated company accounting. But the source of passive income as a shareholder is easy to understand.
A company needs to sell what it makes, cover its costs and have money left over to invest and to distribute to shareholders. In the short term, it may be possible to eat into cash balances or delay capital expenditure to pay dividends. But to pay out dividends regularly for decades, a company needs to generate healthy cash flow with which to fund them.
That’s why for passive income I hold companies in seemingly boring, predictable industries like tobacco. Growth may be limited and the company isn’t glamorous. But a tobacco giant like British American Tobacco has a reliable cash flow that enables it to keep paying out a dividend every quarter, one year after another. The Lucky Strike owner yields over 7%. So putting a little money into it regularly could produce passive income with no work on my part.
Similarly, pharma giant GlaxoSmithKline pays out around 5% at the current share price. GSK has a wide range of products in both its pharmaceutical and consumer divisions. So I expect it to keep paying dividends for a long time. For a company of its quality, a 5% yield is attractive and could help my passive income plans.
Yes, I could work to set up a drop shipping business or some other supposedly-low-maintenance operation. But I find it simpler to earn passive income from proven businesses. That approach also doesn’t take much time, except reading up on investment opportunities to discover what suits me best.