There are lots of ways to try and turn excess cash into passive income. But the best ones produce streams of cash that grow by themselves over time.
Shares in companies that pay dividends are some of the best candidates for this. And investors might be surprised at what could be possible
Opportunities
Right now the average cash savings account in the UK offers a return of around 2.5% a year. At that rate, it takes someone who puts aside £1,000 a month 37 years to make £1,500 a month.
Returns in the stock market are less certain, but the average return from the FTSE 100 over the last five years has been around 8%. That hasn’t all been dividends, but more on that later.
At that rate, £1,000 a month turns into something generating £1,500 in monthly passive income after 10 years. And as well as being quicker, there’s something else that’s important. It doesn’t just take longer at a lower rate of return, you also have to put up more of your own money. At 2.5%, the amount you have to invest is £457,000, compared with £145,000 at 8%.
Dividend stocks
Some companies look to use their profits to generate future growth, while others return them to its owners (us) as dividends. And income investors naturally tend to prefer the latter.
It’s worth noting though, that there’s no free lunch for investors here. A firm retaining its cash naturally increases its intrinsic value in a way that paying it out to shareholders doesn’t.
Over time, that creates upward pressure on the share price. The stock market isn’t always 100% efficient when it comes to pricing this in the short term, but it tends to show up sooner or later.
Nonetheless, companies that can keep generating cash and returning it to investors can be outstanding passive income investments. And there are even some offering 8% returns right now.
Real estate
NewRiver REIT‘s (LSE:NRR) a real estate investment trust that owns and manages a portfolio of retail properties. And the stock currently comes with an 8.25% dividend yield.
In terms of risks, one thing to keep an eye on is the firm’s debt. A major refinancing is coming in the next few years and higher interest rates could put pressure on profit margins.
Importantly though, most of NewRiver REIT’s rental contracts are linked to inflation. And that means they’re also likely to increase over time without the firm needing to do anything.
I’m therefore expecting long-term rent increases to offset a short-term increase in debt costs. On that basis, I think the stock’s well worth considering at a 21% discount to the firm’s net asset value.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
Out of favour
Everyone knows retail properties aren’t seeing the same kind of growth as data centres. But the downside is that data centre REITs like Equinix currently come with dividend yields below 3%.
That means they’re going to have to grow a lot to offset the difference between that and the 8.25% available from NewRiver. And that’s hard in a sector where cash is distributed, rather than retained.
The places to find the best returns are often where others aren’t looking. So I think building a diversified portfolio of stocks like NewRiver REIT might be the best way to earn passive income.
