Having a little more passive income is always handy. I think that’s a sentiment many people share, especially in the current economic environment. And while there are plenty of ways to go about achieving it, investing in the stock market remains my personal favourite.
After all, the barriers to entry today are exceptionally low to the point where just £10 a week is enough to get the ball rolling in securing a lifelong second income. Here’s how.
The snowball effect
In the grand scheme of things, £10 a week is not a lot of money. It’s the equivalent of £520 a year which, when invested at a 5% yield, translates into an annual passive income of £26. Needless to say, this isn’t a life-changing sum. But given sufficient time, compounding may eventually change that.
Every year, this payout would increase when left to reinvest, even if the companies within an income portfolio don’t hike shareholder dividends. Of course, I’m assuming dividends aren’t cut along the way, which is a possibility. However, by carefully selecting top-notch cash-generative enterprises, shareholder rewards may increase, accelerating the snowball effect even further.
Important caveats
Investing isn’t free. Brokerage platforms charge for their services typically in the form of trading commissions on buy and sell orders. Even commission-free services have hidden fees that eat away at investor capital. And when not taken into account, the damage to investor wealth can add up over time.
That’s why it’s probably not sensible to invest with just £10 at a time. Instead, it’s wiser to let this capital accumulate within an interest-bearing savings account. When a more meaningful sum has been gathered, then it can be put to work in the stock market. With this approach, the number of transactions drop significantly. And with it, so do the costs incurred from trading fees, allowing more capital to be invested.
Risk and reward
As previously mentioned, dividends aren’t guaranteed. They exist as a mechanism for companies to return excess earnings to shareholders they have no better use for internally. The key word here is “excess” earnings. If operations are significantly disrupted, profits could become compromised, causing dividends to potentially hit the chopping block.
Every business is subject to external threats, many of which can’t be easily anticipated. So how can investors avoid the risk of investing in a company only to watch it cut shareholder payouts later down the line?
There’s no way to completely eliminate this risk. Even the largest enterprises on the planet have their weaknesses. However, firms with a lot of cash or liquid assets in the bank may be less prone to dividend disruption.
For example, let’s say a corporation is currently tackling supply chain disruptions, causing earnings to shrink. Suppose the problem is only temporary and the business has a substantial cash war chest?
In this case, dividend payments may go undisturbed throughout the storm if management is confident of a swift resolution. However, should the same business be strapped for cash, then payouts may have to be halted in a move to retain financial flexibility.
There are obviously other critical factors to investigate when making an investment decision. But when it comes to generating a passive income, cash is king. At least, that’s what experience has taught me.
