When you think of retirement, you likely associate it with a lack of work. Well at least a lack of working on things you don’t want to! One of these things is having to generate active income. So aiming to generate passive income from investing to top up your pension amount is a real project to start working on right now. The earlier the better, as the power of compounding means that even a small investment made years in advance can be of huge benefit when retirement comes around.
Investing in stocks for passive income
One of my favourite ways to get passive income (both now and for the future) is via dividends. Dividends are paid by companies to their shareholders, usually once or twice a year. You’ll receive a set amount of income per share that you own, so you can work out in advance how much you’re due to receive. Although companies do change the amount they pay out depending on financial performance for that year, many firms have a commitment to paying out something every single year.
Dividend income is a great form of passive income because you don’t need to lift a finger to earn it. By investing in a company, you let the business do the hard work to generate the income for you. You can be more active in this by researching the firm you want to invest in, and adjust the rate of income by assessing the dividend yield of the company in question.
Using £78 per week
The current average dividend yield of the FTSE 100 is 3.75%. So if you invested £78 this week, you’d earn just under £3 annually in dividend income. Not massively exciting, but hold on. £78 per week would mean you invest £4,056 over the course of the year. So on a rolling annual basis you’d be getting over £152 in passive income from investing.
There are two ways this amount can really start to add up for when you retire. Firstly, you benefit from reinvestment. This is all about the compounding I mentioned earlier. After you’ve been investing for a year, you receive dividend income that you can reinvest straight away. On a rolling basis, not only are you investing £78 weekly, but you can invest the extra £152 from the previous year. This £152 from the first year can then earn income of its own. You’re making passive income from passive income.
Secondly, you benefit from time. £78 a week doesn’t seem a lot to some people, but invest regularly like this over the course of a decade or more and you’ll see how this adds up. If retirement is 10 years away, you’ll have an investment pot of over £40,000 ready if you stick to the schedule. Regular investing could even help you to retire early due to the potential share price appreciation and compounded returns in the long run.
Where to start?
I recently wrote about three cheap dividend stocks that I like right now. Even during a pandemic these firms are still paying out income. They’re Hargreaves Lansdown, Hikma Pharmaceuticals and Coca-Cola HBC. But there are plenty more like them out there and The Motley Fool has lots of pointers to help you track them down.
jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has recommended Hargreaves Lansdown and Hikma Pharmaceuticals. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.