Of all the forms of earnings, I like passive income most. That’s because I’m lazy, so I love getting money for nothing. Passive income is unearned, so it rolls in without work or effort — even while I sleep.
For me, the beauty of unearned income is that it can build up over decades into significant sums. Indeed, through careful, regular investing, it’s possible to retire five, 10 or even 20 years early, living off unearned income.
Types of passive income
There are many ways to generate passive income. For example, renting out property, collecting coupons (interest) by buying government bonds, or getting cash interest on savings. And a large proportion of the UK’s total unearned income comes from pensions (either personal, company or state).
But my favourite way to collect passive income is by investing in dividend-paying shares. Dividends are regular cash payouts paid to shareholders by companies, typically quarterly or half-yearly. Not all companies pay dividends, but most FTSE 100 shares do. Then again, share dividends are not guaranteed, so they can be cut or cancelled at any time. Indeed, this happened widely during 2020’s Covid-19 crisis.
How unearned income snowballs
I’ve been investing in shares since 1986/87, while my wife started buying stocks after graduating in 1989. In other words, we’ve had almost seven decades between us of building capital by buying income shares. And the results have been pretty impressive, with some of our least ‘exciting’ shares and investment funds delivering the most spectacular returns.
One thing we’ve always done over the decades is to reinvest our share dividends, using this cash to buy yet more shares. This has turbocharged our returns, allowing our family portfolio to grow far faster over time. Indeed, studies suggest that around half of the long-term returns from UK shares come from reinvested dividends. Woohoo!
Early retirement is an option
My wife and I are both 54. We have a comfortable home with a small outstanding mortgage and no other debts. We also have enough money invested that we could retire today, should we choose to. But my wife loves her (very rewarding) work and plans to keep working until perhaps 65. But the option of early retirement is always there — for example, following job loss or ill-health.
Even better, my wife qualifies for an early-payment pension next year, which kicks in on her 55th birthday. This will deliver around £1,250 a month extra after tax, starting in the second half of 2023. However, we plan not to spend this passive income. Instead, we aim to reinvest it into yet more cheap shares, ideally buying them inside Stocks and Shares ISAs and private pensions.
Looking ahead to the future, I expect our pension pots and ISAs to continue to grow over the next 10 years. If global stock markets do better than expected, then this may accelerate our early retirement. If shares slump again, we may decide to keep working for a couple more years.
But the one thing decades of building passive income have done for us is provide financial freedom. As well as securing our retirement, it allows us to help our children through university and into working life. And I also hope to have a few more fancy holidays before I shuffle off this mortal coil!