What is passive income, anyway? And why do I love it so much?

When I first started investing in the late 1980s, I was studying maths, statistics, and computer science. This gave me a leg-up in understanding financial markets, so I’ve been trying to build wealth ever since. However, I often hear students and young people say they ‘hate maths’ and don’t understand investing. So here’s my quick guide to one of my favourite things: passive income.

What is passive income?

Passive income is earnings that come other than from paid work. Nevertheless, some passive income requires hard work, such as managing rented properties — dealing with tenants and their problems. I’m too lazy for this, so I haven’t built a property empire.

Unearned income can come with little effort, such as savings interest from cash deposits. That said, I don’t know many people who got rich from avoiding all risks, so I don’t keep tons of cash in savings accounts.

Owning bonds is riskier than saving in cash, because these fixed-income securities are IOUs (debts) issued by companies and governments. If trouble arrives, their coupons (interest) and capital (the initial investment) could be under threat. Even so, my wife and I own a wide range of bonds through a single money-market fund.

My favourite unearned income

However, my preferred form of passive income by far is share dividends. Some people believe that owning shares is no better than buying lottery tickets. However, my goal is to become part-owner of a wide range of great businesses. And when these companies do well, many of them choose to pay out dividends to shareholders.

Most members of the UK’s FTSE 100 index pay dividends. This makes the Footsie my happy hunting ground for generating passive income. Still, future payouts are not guaranteed, so they can be cut or cancelled at short notice (as happened in Covid-hit 2020/21). But as American tycoon John D Rockefeller once remarked, it gives me great pleasure to see my dividends coming in.

A dividend diamond

Here’s one example of a dividend dynamo within my family portfolio. Phoenix Group Holdings (LSE: PHNX) is a FTSE 100 firm that specialises in buying, managing, and running off existing books of insurance policies and pensions. In other words, it operates in the long-term savings and retirement sector.

Managing other people’s money can be a lucrative industry, so my wife and I bought this stock for its delicious dividend yield. In August 2023, we paid 514.9p a share for our stake in this British business.

As I write, Phoenix shares trade at 638.5p, valuing this group at £6.4bn. Therefore, we are sitting on a paper gain of 24% in under two years — pretty good for a ‘boring’ UK stock. Meanwhile, its dividend yield is now 8.4% a year — one of the highest on the London stock market. By contrast, the wider FTSE 100 offers a yearly dividend yield of 3.6%.

Of course, things might go wrong with this investment (and with any dividend share). Phoenix is a small player in a huge global market, so it faces stiff competition from big rivals. Also, fund fees are shrinking and future investment returns could be lower. Or Phoenix might get taken over one day? Whatever, I will keep owning this share for its impressive passive income!

The post What is passive income, anyway? And why do I love it so much? appeared first on The Motley Fool UK.

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The Motley Fool UK has no position in any of the shares mentioned. Cliff D’Arcy has an economic interest in Phoenix Group Holdings shares. 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.