The recent decline in the stock market may convince some investors that generating a passive income from stocks is too risky. In fact, some companies have cut or cancelled their dividends in response to the uncertain outlook facing the world economy.
However, stocks with defensive characteristics may be worthy of consideration for investors who are seeking a passive income. They may offer a relatively robust financial outlook that means their dividends are affordable. Following recent stock price falls, they could also offer a high income return as part of a diverse portfolio of stocks.
Defensive qualities
Companies with defensive characteristics are less likely to be impacted by changes in the outlook for the economy. For example, their sales and profitability may not increase by a significant amount during economic booms. Likewise, their financial performance could be relatively unchanged during an economic downturn.
As such, the uncertain outlook for the world economy may fail to impact on the affordability of their dividends. For passive income investors, this could equate to a robust passive income that continues to grow at a rate that is equal to, or even above, inflation over the long run. Therefore, buying defensive stocks may mean your passive income is more reliable than it would be through buying cyclical stocks with financial prospects that are more dependent on the performance of the economy.
High passive income returns
Defensive stocks may be able to afford to pay their current dividends over the medium term. But, in many cases, the recent stock market decline has hurt investor sentiment towards them.
This means many defensive, passive income shares now offer high dividends yields that are above their historic averages. This suggests now could be the right time to buy them, since high yields can be an indicator of a margin of safety.
Therefore, as well as obtaining relatively high yields due to recent stock price falls, you may be able to generate capital growth over the coming years. Defensive stocks may become more popular alongside the wider stock market. This is because investor sentiment towards equities gradually improves in the coming years.
Risk reduction
Of course, a company’s defensive status doesn’t guarantee it will produce a solid passive income. Any company can experience unforeseen challenges that weigh on its financial performance.
As such, it’s crucial to purchase a diverse range of companies that operate in different sectors when building a passive income portfolio. This may include businesses that have exposure to varied industries and geographies to further reduce risks.
By spreading your capital across multiple industries and regions, you’ll become less reliant on a small number of sectors and geographies. This could further improve the reliability of your passive income. It will also enable you to enjoy a growing level of financial freedom over the long run.