I’ve just searched for ‘top passive income secrets’, and there are some strange ideas out there. People are touting all sorts of things, from writing an eBook, to buying whisky casks, and even investing in vending machines. Good luck to anyone trying to retire using those.
But by far my favourite suggestion is to invest in dividend shares. Stocks and shares have a very long track record of beating other forms of investment. So how do the best dividend share investors maximise their returns?
Reinvest dividends
Firstly, every bit of extra we can stash away can add quite a bit to our eventual passive income pot. Suppose we invest £500 per month in dividend shares paying 5% per year, and the share price itself grows at 2% per year. If we spend the dividends every year, after 30 years we should be left with £246,000.
But if we reinvest those dividends in more of the same shares, that total would reach more than £588,000 after three decades. Reinvesting dividends makes a big difference
Dependability
The best long-term passive income investors look for dividends that grow progressively, year after year. In the UK, the Association of Investment Companies has put together a list of ‘Dividend Heroes’. That’s all the companies (mostly investment trusts) that have raised their dividends for at least 20 years in a row. Some have managed it for more than 50 years.
The US S&P 500 Dividend Aristocrats index is similar. That includes all the index’s stocks that have lifted their dividends every year for 25 years, or more.
Time is key
Let’s look back to our 5% dividend example. We’ve seen how we might accumulate £588,000 over 30 years that way. But add another 10 years, and the total reaches £1.24m. A 33% longer investing timescale nets us more than twice the cash.
Albert Einstein is often credited as describing compound interest as the eighth wonder of the world. Whether the man who discovered General Relativity actually said it or not, time plus compound returns can greatly increase our passive income.
Diversify
All this might sound good, but it’s important to remember that there’s no such thing as a no-risk investment. Companies paying good dividends today might fall on hard times tomorrow and be unable to keep paying.
Choosing from those with very strong dividend track records can help there, but there’s another approach too. Investors who diversify and hold a wide range of dividend-paying shares should face less pain should one of them turn bad.
It can help to pick from different sectors too. Diversification doesn’t eliminate risk, but it can help reduce it.
Get rich slowly
There’s nothing earth-shattering in these ideas. It’s essentially all down to simple principles. It’s really all about investing as much as we can, in dependable dividend-paying shares, and spreading our cash to reduce risk. Then we let time weave its magic.
The very best passive income investors know that the chances of getting rich quick are vanishingly small. But they’re more than happy to be patient and get rich slowly.