Holding funds in cash for a rainy day is never a bad idea. Yet having an excess of cash sitting on account can be counter intuitive at the moment. After all, most big banks aren’t passing on the higher interest rates on normal cash accounts.
With inflation still elevated, this means the funds are getting eroded in value. To make the money generate a passive income, here’s how I’d go about putting £10k of savings to work.
Understanding the process
To squeeze an income out of my existing money, I’d turn to dividend-paying stocks. It’s passive in the sense that once I’ve bought the stock, I don’t have to actively do anything to be in line to receive a dividend. Rather, as a shareholder of the business, I have a right to get a slice of whatever earnings are paid out.
In an ideal world, I purchase a selection of top dividend stocks with my £10k that are performing well. Over the course of the coming years, this should result in generous income payments. When I compare the annual dividend per share to the share price I bought at, I can generate a dividend yield figure.
This percentage helps me to compare the income I’m making relative to other potential income streams. For example, if I own Aviva shares that have a current yield of 7.98%, I can assess this against current Cash ISA rates, bond yields and even buy-to-let property returns. At a rough glance, Aviva shares come out on top in this comparison.
How £175 a month is obtainable
£175 a month equates to £2,100 a year. This might sound rather ridiculous to be possible from a £10k standing start.
However, most are forgetting about the benefits around compounding. I’m going to assume that I can pick a dozen stocks with a blended average dividend yield of 7%. Based on current stock yields, I don’t feel this is unreasonable.
Each time a dividend is received, I’ll reinvest it back into buying more shares. That way, my overall investment pot grows in value quicker. Over time, this can really make a difference. So much, in fact, that after 16 years, my £10k would turn into over £30,500. When I break this down, it equates to £177 per month (on average).
Risk and reward
Trying to forecast that far in advance is always difficult. A stock I buy today might have to cut the dividend payment years down the line due to unforeseen circumstances. This could throw off my projected income levels.
I also might have to be more active in nature, selling stocks along the way that no longer pay income. These are both risks to my strategy.
However, to take a lump sum now and build it up to a level where I can earn generous income in the future is a reward I believe outweighs the potential risks.
