Though I enjoy writing for a living, earning a wage isn’t my favourite way to live. I prefer the freedom of having multiple sources of passive income. Helpfully, this unearned income works when I don’t, both night and day.
Five popular forms of passive income
Here are five types of passive income that I use to boost my earnings:
1) Savings interest
Cash on deposit usually earns savings interest. But after the global financial crisis of 2007/09, interest rates fell to new lows. Savings interest rates crumbled, some to near-zero levels.
With interest rates now rising, some easy-access accounts pay 3% a year before tax. This is good news for long-suffering British pensioners, whose nest eggs have been eroded by inflation (rising prices).
2) Bond coupons
Bonds are fixed-interest IOUs issued by governments and companies. Say I lend my money to HM Government by buying UK Gilts. In return, I receive regular bond coupons (interest payments), with my capital returned in full when the bonds mature.
When interest rates were ultra-low, high-quality bonds paid tiny coupons. Thus, my portfolio held no bonds for many years. But with rates creeping up, I might buy some solid bonds for long-term income.
3) Share dividends
Of all forms of passive income, share dividends are my absolute favourite. The majority of my unearned income comes from these regular cash payouts. However, not all listed companies pay dividends — in fact, most don’t.
Also, future dividends are not guaranteed and can be cut or cancelled without notice. Dozens of major companies reduced or withdrew their dividends during 2020’s Covid-19 crisis. Fortunately, almost all members of the FTSE 100 pay dividends, making the Footsie my happy hunting ground for juicy cash yields.
4) Capital gains
Capital gains are profits I make by selling shares at prices higher than I paid. It’s possible to generate passive income by selling small batches of shares at a profit. This is broadly similar to collecting share dividends, but capital gains are taxed much less heavily.
Say I buy £10,000 of shares that then rise a tenth (+10%) to be worth £11,000. I might sell £1,000 of the shares, leaving my original £10,000 invested. In effect, I have delivered a 10% ‘pseudo-dividend’ to myself by collecting this capital gain. And sheltering these gains inside tax shelters keeps the taxman at bay.
5) Pensions
While pensions may appear daunting and mysterious, they are just another type of investment pot. The goal is that I systematically put money aside throughout my working life. When I retire, I then use this accumulated pot to generate passive income to replace my earnings. And after many decades, pension investing can produce impressively large pots.
For instance, my wife’s pension pot is worth way more than our home, because she invested a large slice of her earnings into it for 33 years. Today, it’s one of our biggest financial assets and is set to produce enough passive income to keep us until we die. And in her will, she has gifted this asset to our children, to help them cope with the crushing cost of modern life!
