There are lots of passive income ideas. Not all are created equal – or even vaguely equal. One of my favourite passive income ideas is investing in dividend shares. But not everyone understands dividend shares, or their potential to generate extra money for their owners. Here are three reasons I like them.
1. World class businesses
If I put money into a bank account, I basically receive the payment the bank is getting from other customers to borrow it, minus the bank’s cut. In a competitive financial services market with low interest rates for now, that means that my likely passive income will be fairly meagre.
By contrast, investing in dividend shares allows me to benefit from large, well-established businesses generating substantial profits. An example is British American Tobacco. One of the leading tobacco business globally, its shares currently yield 8%. In other words, if I invested £1,000 today, I would expect to receive £80 in dividend income annually.
Now, there’s a risk that won’t happen. Dividends aren’t guaranteed and as cigarette use falls, so might profits at British American Tobacco. But by diversifying my passive income streams across a number of shares, I seek to benefit from the business expertise of successful companies. I expect that to offer greater possible returns than bank interest.
2. In and out
I am an investor, not a speculator. So I don’t try to move in and out of shares quickly. Instead, I aim to choose companies I think have strong long-term potential. I then buy them in my portfolio to hold.
However, that doesn’t mean I never sell. Of course, circumstances can change and a company’s outlook can vary from one year to the next. If I set up my own business to generate passive income, moving in and out of it might not be so easy. Even if the idea was truly passive, it would likely take me time and effort to establish it. Then, if I wanted to exit it, I would need to find a buyer if I wanted to try and recoup my investment.
With shares, by contrast, the start-up time is minimal — and that’s also true when I decide to end my investment. I can put funds into a share on the same day I decide I like it. Equally, when I think it’s time to sell, I can move to action immediately.
3. Passive income and business education
Owning dividend shares enables me to get income without working for it. But that doesn’t mean I never spend time developing my passive income ideas.
I tend to take time to read up on companies’ performance when assessing what the right opportunities for me as an investor might be. Over time, that reading can help me learn not just about the specific firm. It can also give me a growing education in business and finance generally. It’s not an MBA, that’s true. But it’s still a free, practical education based on real-life businesses. For my personal development, I think that can be very helpful.
Christopher Ruane owns shares in British American Tobacco. The Motley Fool UK has recommended British American Tobacco. 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.
