Passive Income The Best There Is
If any of you have met me – you know I’m mad crazy about dividends and interest payments. The other day, I was trying to explain to a friend what dividends are and why he shouldn’t sell dividend stocks (dividend growth stocks) and hold them for life. Plain & Simple dividends are a set sum of money (that could change over time) that is paid out to shareholders from the company’s bottom-line. . Why do companies pay out dividends? Many of times it is an incentive to own the stock as the stock does not grow a lot. If the company did not offer a dividend many people would not own a stock. Dividends form the basis of passive income – income that you did not work for. By building reliable passive income streams it will allow you to save more for that down payment or car you need so bad or trip to Europe, pay off debt and use for whatever you please. One of the reasons I love dividend stocks is not only does it give me passive income now but also the payout grows every year (in most cases). So while 50 cents does not seem like much per share today – it can easily grow to a dollar in several years.
Why Passive Income?
When people are confused with passive income and why they should start a passive income stream – I go back to my famous chicken and egg comparison. Suppose you really liked eggs and didn’t have any in the morning. Suddenly there’s a knock on your door and someone either offers you a dozen eggs or a chicken. Which one would you take?
I would take the chicken and even though it would take a while to accumulate eggs I would have eggs for as long as the chicken lives. If I need more eggs I get more chickens and the metaphor continues. People ask me so what do you do when the chicken dies? You get a new one! The same applies to passive income you can only milk something so many times but think of how much you have gotten before it is exhausted. The chicken will also live for years – like stocks with re-balancing done accordingly. In addition, the majority of dividends paying companies are large conglomerates, utilities or financial firms. These companies have millions in assets and are likely to stick around for awhile.
The reason why I love passive income so much is because I use it to cover my expenses while my active income is used to generate more passive income. It also helps that dividend income is preferentially taxed compared to other incomes so there is an extra incentive to earn more in the form of dividends. You can also use dividends to enrol in a DRIP (dividend re-investment plan) where you can experience the true compounding effect of dividends. With a DRIP dividends will be used to buy more shares. For example, lets say a company has a stock of 10$ and you earn 100 shares. The company also pays 10 cents a share in dividends a quarter. This means every quarter instead of receiving 10$ you buy another share. This way every quarter that passes your share count grows and dividends increase as well. To learn more about the compounding effect check out our compounding podcast
I have spoken a lot on the subject of dividends this week but you can also obtain passive income from other streams. Rent is one that comes to mind as well as small ownership stakes in companies that provide you with royalties. As you build your portfolio you will realize the influence that passive income can have in your portfolio and how various alternatives can be utilized to generate more passive income.
My recommendations to everyone are to set aside money to invest in any types of investment that generate passive income that will supplement their active income eg: employment or core business income.
Remember it takes awhile for dividends to grow an build. It can take awhile to accrue dividend income. Be patient and stick with the process and by the end you would have built a portfolio that consistently churns out passive income.
For more on dividend investing check out my previous article on employing a dividend strategy over the long term.
Disclaimer: All of the above information is my own personal opinion. Please consult with a licensed representative or financial advisor before making any financial decision. Stories/situations listed above are for examples only. Dividends are preferentially taxed but rate varies based on your tax bracket.
Thumbnail Image: http://creatingapassiveincome.com