Passive income is earnings derived from an activity or enterprise without being actively involved.
Cool, right? Earnings with no effort. Get rich while we sleep. The lazy person’s rout to wealth. Count me in!
Routes to passive income
But how can we get it? One method is to stash some money in a cash savings account and harvest the interest. But there’s a problem with that one — bank interest rates are so low that my earnings won’t keep pace with inflation and I’ll end up losing some of the spending power of my money.
I could rent out a room in my home. That would do it. But not without consequences. For example, wear and tear to fixtures and fittings could add up to a ‘hidden’ cost over time. And then there’s the loss of privacy. That one’s not for me.
How about writing a hit pop song and collecting the royalties? Perfect! But that won’t work for everyone. And neither will writing a book and earning royalties on ongoing sales until the end of time.
I could patent an invention and earn royalties every time someone uses it. But, again, such a route is only open to the well-placed few, and not to the many.
One approach taken by many people is to buy an investment property and collect rents. But there’s actually quite a lot of work that comes with a business like that. It’s almost impossible to be inactive while holding physical property. So it barely qualifies as passive income.
The supreme strategy for me
But one strategy I will follow for my £5-a-day passive income plan is to invest in dividend-paying stocks. Companies are great because they run businesses that generate income streams with the potential to grow while I own their shares.
Although I can passively sit back once I’ve bought shares, the businesses behind them will be active. And their over-riding mission in life will be to increase the passive income they are paying to me and the other shareholders.
And I don’t even have to go to all the trouble of selecting which shares to buy. My favoured approach would be to invest regular sums of money into low-cost index tracker funds, such as those that follow the fortunes of the FTSE 100, FTSE 250 and small-cap indices. And I’d diversify by country as well and track America’s S&P 500 index, among others.
One of the useful things about tracker funds is that they are underpinned by many stocks. So, by selecting trackers, I’m getting wide diversification. And when my funds have built up a bit, I’d likely diversify into some stalwart stocks of individual companies, such as Unilever and GlaxoSmithKline.
A £5-a-day investment would give me around £153 to invest every month and that’s a useful sum to get started. There are no guarantees of positive returns from stock market investing. But the activity has a good long-term record and my expectation is that my passive income strategy would be successful over time.