Image source: Getty Images
Generating passive income without working may sound too good to be true. However, this strategy has been used very effectively by many stock market investors for decades.
If my £50k cash savings were to lose their purchasing power due to the corrosive effects of inflation, I would take steps to change that today. By investing in dividend stocks, I may be able to beat inflation in the long run and eventually secure a steady stream of £2,000 monthly passive income.
This is how I pursue that goal.
Is the king of cash?
Cash savings rates skyrocketed. Thanks to the Bank of England’s efforts to tame runaway inflation, the base rate has been rising consistently for 13 months in a row and is now at 5%.
As I write, savers can benefit up to a rate of 4.45% on easily accessible accounts or as high as 6.15% for a fixed period.
However, the CPI inflation rate is still hot at 8.7%. Even with the highest rates seen since 2008, the savings on cash parking mean they’re not offsetting the price increases. So, what are the alternatives?
Personally, I would invest in the stock market.
But, isn’t that risky?
Risks and rewards
Unlike cash, there is no guaranteed rate of return. In fact, the FTSE 100 index is slightly down from the start of the year. So far, cash has underperformed to the disappointment of investors. If so, why did I bother investing in stocks?
Well, over the long term, they historically beat cash. The FTSE 100 has provided historic returns of between 6% and 8% annually. The more volatile FTSE 250 index has performed better. And both have been beaten in recent years by expansive growth in the S&P 500.
While past performance does not guarantee future returns, I think the company will continue to innovate and grow. For example, the ongoing AI revolution is a great testament to the potential of technology breakthroughs to drive revenue expansion.
That doesn’t mean there isn’t room for cash in my portfolio. It’s wise to keep an emergency fund, as stocks are volatile investments. But, with £50k left and passive income on my mind, I’ll be shifting my focus to dividend stocks.
By investing in a diversified mix of dividend stocks I think I can get a return of 4% across my entire portfolio. That’s slightly higher than the FTSE 100 average of 3.8%.
If I owned a few high yielding stocks like Aviva (7.9%), British American Tobacco (8.8%), and Glencore (7.8%), I think this could be achieved.
So, to get my £2k a month in dividends, I need to turn my £50k into £600k.
It’s no mean feat, but I’m in it for the long haul. If I reinvest my dividends and let my shares grow over time, I will reach my target in 35 years with a compound annual growth rate of 7.36%.
If I could invest that money by the age of 30 I would be making £2k in monthly passive income by my 65th birthday without contributing another cent!
Granted, the companies I invest in can underperform or cut their dividends. This could mean I need to invest more or wait longer. That said, when it comes to long-term investing for passive income, dividend stocks are where I start.