With most of my investments, I try to generate passive income. I know that by doing so, I’m setting myself up for a more comfortable retirement.
I could own property or start a side hustle. But I want to make it as hassle-free as possible. That’s why I love dividend shares.
For very little work, I can start making some extra cash. Warren Buffett once said: “If you don’t find a way to make money while you sleep, you’ll work until you die”.
Here’s how £5,000 in savings could turn into a juicy stream of passive income.
A dividend stock
To achieve this, I’d target shares with index-leading yields. One stock I’d consider buying today is Phoenix Group Holdings (LSE: PHNX). It pays the highest yield on the Footsie at 10.6%.
I think there’s a lot to like about the business when considering its shares. It has plenty of cash on hand. For example, last year it achieved over £2bn of cash generation. Its balance sheet looks in good health with a Solvency II ratio of 176%. And after a positive set of results last year, the firm is now targeting £900m of IFRS-adjusted operating profit in 2026. For context, it was £617m for 2023.
To go with that, it hiked its dividend payment for fours year on the bounce. There are other aspects about the insurance giant that make me bullish, such as its Pension and Savings business.
I do see some risks with the stock. High interest rates continue to pose a challenge. For one, they fuel uncertainty about the economy. They can also impact the valuation of assets. Furthermore, the insurance industry is cyclical and there’s the threat of competition. However, I think Phoenix Group is a quality company with long-term potential.
Crunching the numbers
I want to use Phoenix Group’s yield as an example of how £5,000 can turn into a handsome stream of passive income later down the line. But before that, I point out something.
Dividends are never, ever guaranteed. We only have to look back a few years to the pandemic when numerous companies reduced or slashed their payouts as profits were hit. We’ve also seen it before with events such as the Global Financial Crash. The market is unpredictable, so it’s worth bearing this in mind.
That said, taking Phoenix Group’s 10.6% and applying it to my £5,000 would earn me £530 in passive income a year. That would come in handy. But that’s not going to be enough to supplement my lifestyle when I retire.
To reach a figure that will, I’d reinvest my dividends. By doing so, I’d benefit from compounding. Essentially, I’d be earning interest on my interest. Over the years, this would snowball my gains.
Doing this for 25 years could see my £5,000 turn into an investment pot worth £69,952. By year 25, I’d be earning just over £7,000 a year in interest.
If I had the spare cash, I could invest a further £100 a month. Doing that for 25 years would leave my pot sitting at £217,012. After year 25, I’d be earning £21,669 a year in interest. That would most definitely set me up for a more lavish lifestyle after giving up work.
This post was originally published on Motley Fool
