After 35 years of investing, my hero remains mega-billionaire and philanthropist Warren Buffett. Despite giving away $48bn to good causes, the 92-year-old ‘Oracle of Omaha’ still has a personal fortune of $96bn. And my favourite Buffett saying about passive income is: “If you don’t find a way to make money while you sleep, you will work until you die”.
How I generate passive income
I love passive income: the earnings I make without effort, without working, and even while I sleep. Rather than slaving away in another job or side hustle, I generate passive income from my assets.
I don’t own any investment property/real estate, so I don’t collect rental income from tenants. Also, I don’t expect to get rich by saving, so I don’t keep piles of cash in deposit accounts. Likewise, I don’t own any government and corporate bonds, so I don’t get interest from these fixed-income securities.
For me, history has shown that the best way to generate passive income is by buying equities (stocks and shares) that pay dividends. These are regular cash payments paid by companies to shareholders, usually half-yearly or quarterly.
The big problem with share dividends
Right now, cheap UK shares offer some of the highest dividend yields among major asset classes. For example, the FTSE 100 index has a cash yield of 4.2% a year. But dozens of UK-listed shares offer much higher levels of passive income than this.
Now for the bad news: company dividends are not guaranteed, so they can be cut or cancelled at any time. During the Covid-19 crisis of 2020, many big businesses cut or cancelled their cash pay-outs. Similarly, if the UK economy goes into recession in 2022-23, then company dividends might decline.
When share prices slump
As an example of one FTSE 100 share that I own to generate passive income, take UK housebuilder Persimmon (LSE: PSN). Alas, this stock has had a terrible 2022; here’s how it’s fallen over various timescales:
| One day | -2.8% |
| Five days | -0.7% |
| One month | -14.0% |
| Six months | -46.4% |
| 2022 YTD | -57.7% |
| One year | -54.1% |
| Five years | -57.5% |
This share has lost value over all seven periods, ranging from one day to five years. Gruesome. But as share prices decline, dividend yields rise (all else being equal). As a result, the potential passive income from this stock has skyrocketed this year.
This income share yields nearly 20% a year
As I write, this share trades at 1,213.5p, giving it a market value of £3.8bn. Yet the group’s latest full-year dividend of 235p a share equates to a dividend yield of 19.5% a year. In my experience, it’s very rare for FTSE 100 dividend yields to reach such elevated levels. Either share prices rebound and cash yields reduce, or dividends get slashed and yields drop.
As things stand, if I bought 426 Persimmon shares today, it would cost me around £5,170. If — and that’s a big if — the company doesn’t cut its dividend, then 235p times by 426 shares produces passive income of £1,001.10 a year for me. Wow.
Then again, with energy bills soaring and interest rates rising, I’m expecting an economic recession in 2023 and tough times for the UK housing market. Even so, I won’t sell my shares in Persimmon — not for now, at least!