Earning passive income without needing to work for it might sound too good to be true. But, this strategy has been deployed to great effect by many stock market investors throughout the decades.
If I had £50k in cash savings losing its purchasing power to inflation‘s corrosive effects, I’d take steps to change that today. By investing in dividend shares, I might be able to outpace inflation over the long term and eventually secure a £2,000 monthly passive income stream.
Here’s how I’d pursue that goal.
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Is cash king?
Cash savings rates are rocketing. Thanks to the Bank of England’s quest to tame runaway inflation, the base rate has consistently risen for 13 consecutive months and now stands at 5%.
As I write, savers can benefit from up to a 4.45% rate on an easy-access account or as high as 6.15% for fixed periods.
However, the CPI inflation rate is still running hot at 8.7%. Even at the highest rates seen since 2008, parking savings in cash means they’re not keeping pace with rising prices. So, what’s the alternative?
Personally, I’d invest in the stock market.
But, isn’t that risky?
Risk and reward
Unlike cash, there’s no guaranteed rate of return. In fact, the FTSE 100 index is down slightly from where it started the year. So far, it’s underperforming cash to the disappointment of investors. If that’s so, why would I bother investing in stocks?
Well, over long time periods, they’ve historically beaten cash. The FTSE 100 has delivered historic returns between 6% and 8% per year. The more volatile FTSE 250 index has performed even better. And both have been trumped in recent years by expansive growth in the S&P 500.
Although past performance doesn’t guarantee future returns, I think companies will continue to innovate and grow. For instance, the ongoing AI revolution is good evidence of the potential of technological breakthroughs to drive earnings expansion.
That doesn’t mean there’s no place for cash in my portfolio. It’s prudent to keep a emergency fund, since stocks are volatile investments. But, with £50k to spare and passive income on my mind, I’d turn my focus to dividend stocks.
Compound returns
By investing in a diversified mix of dividend shares, I reckon I could secure a 4% yield across my portfolio. That’s slightly higher than the FTSE 100 average of 3.8%.
If I owned some high-yield stocks like Aviva (7.9%), British American Tobacco (8.8%), and Glencore (7.8%), I reckon this would be achievable.
So, to earn £2k a month in dividends, I’d need to turn my £50k into £600k.
That’s no mean feat, but I’m in it for the long run. If I reinvested my dividends and let my stocks compound over time, I’d hit my target in 35 years at a compound annual growth rate of 7.36%.
If I could invest that money at the age of 30, I’d be earning £2k in monthly passive income on my 65th birthday without contributing a single penny more!
Granted, the companies I invest in could underperform or cut their dividends. This could mean I’d need to invest more or wait longer. Nonetheless, when it comes to long-term investing for passive income, dividend shares are where I’d start.
