Best Passive Income Ideas for 2022 – Forbes Advisor UK

The current cost of living crisis is encouraging people to find additional sources of income to cover rising food, oil and energy bills. So-called “passive” income can be a good way to supplement your household income to provide a margin of safety when finances are tight.

Fortunately, there are a growing number of passive income options, with the pandemic opening up innovative ways to earn some much-needed extra cash. Let’s take a closer look at how you could earn passive income.

What is Passive Income?

Passive income refers to income that does not require a large commitment of time or money. Although most passive income ideas require some time, money, or resources upfront, they should only require minimal monitoring on an ongoing basis.

There are three main types of passive income streams:

  • Investment: generating a return by investing money in savings accounts or in the stock market.
  • Asset Sharing: Selling or renting assets you own, like your house or car.
  • Building Assets: Examples might include adding revenue-generating affiliate links to your blog or website or selling resources such as e-books, educational content, music, and photos online.

While all of these categories have the potential to generate substantial income, here are some of our top suggestions for earning passive income in the UK.

Best Passive Income Ideas

Investment dividends

Dividends are paid by companies to their shareholders and can provide a good stream of passive income if you have funds to invest. However, they are not guaranteed and many companies have temporarily suspended their dividend payments during the pandemic.

the dividend yield is a good indicator of the “return” on your investment, similar to the annual rate of a savings account. It is calculated as the dividend payment divided by the price of the share (or investment). So if a company with a share price of £100 pays an annual dividend of £4, its dividend yield would be 4%.

There are three main ways to earn a stream of dividends from investments, all of which can be held in a Stocks & Shares Individual Savings Account without incurring income tax.

a. Company shares

Some companies, but not all, pay dividends to their shareholders. Dividends are generally paid in cash on a quarterly or semi-annual basis. Companies can also pay one-time “special” dividends to return money to shareholders, for example, after the sale of a company.

Global dividends hit a record high of £1.2 trillion in 2021, according to investment house Janus Henderson, thanks in part to a boom in dividends paid by mining companies.

However, there may be a trade-off between dividend payouts and share price growth. “Growth” stocks such as Tesla, Amazon and Meta have never paid dividends, preferring to invest excess cash to generate future growth.

In comparison, more traditional blue chip companies tend to pay higher dividends. Investors’ Chronicle reports that the average dividend yield for the FTSE 100 and Nasdaq is currently 3.3% and 0.7% respectively.

This illustrates the higher proportion of dividend-paying industrial companies in the FTSE 100 compared to the technology-heavy Nasdaq.

However, caution should be exercised in the case of stocks with very high dividend yields, which can occur if the stock price drops sharply, artificially inflating the dividend yield. This means that fundamentals other than dividend yield should also be considered when looking for an opportunity to buy a company’s stock.

b. Investment trusts

Investment trusts invest in assets such as stocks, and the majority of trusts pay dividends to investors. Like stocks, investment trusts have a “live” trading price that can go up or down depending on demand.

The advantage of investment trusts (compared to funds – see below) is that they are allowed to retain 15% of annual income to build up a “rainy day” cash reserve, allowing them to maintain consistent dividend payments in the event of a market downturn.

According to the Association of Investment Companies’ latest “Dividend Heroes” list, seven investment trusts have increased their dividends for more than 50 consecutive years.

As with stocks, dividend yields should be considered alongside other factors if you are looking to buy an investment trust, especially its future prospects for share price growth. There are a variety of investment trusts to choose from, including specialized equity income trusts and trusts focused on different sectors such as technology, real estate and commodities, as well as different geographic regions.

vs. Funds

Funds are similar to investment trusts in that they hold an actively managed portfolio of stocks and other assets. However, they do not have “live” prices and are repriced once a day based on the value of their underlying assets.

Although many funds pay income in addition to capital growth, funds whose primary objective is to pay income can be found in the UK and Global Equity Income categories. According to investment information provider Trustnet, most UK equity income funds currently pay a dividend yield of between 3% and 5%.

When purchasing funds, you may be offered a choice of distribution or capitalization units. Distribution units pay cash dividends to investors. With accumulating shares, dividends are used to purchase additional shares in the fund, providing the opportunity for future capital growth by reinvesting dividends.

Interest from savings accounts and bonds

a) Company shares

Depositing your money in a savings account also produces passive income. Easy Access Savings Accounts currently earn up to 1.2%, while regular mainstream savings accounts offer rates of up to 2.0%, although these usually have a monthly limit of £100-500.

It is worth reviewing the interest rate regularly, as it may include a bonus rate for a limited period. In addition, banks cannot pass on any increase in the Bank of England base rate in full to customers with variable interest rate accounts.

You should also check that your account is covered by the Financial Services Compensation Scheme, which protects customers up to £85,000 if a bank or building society fails.

Although investing in savings accounts is less risky than the stock market, the average return has also been historically lower. Given the current inflation rate of 7%, money invested in savings accounts paying an interest rate of 1% will effectively lose 6% in real terms each year.

b) Fixed rate bonds

Fixed rate bonds are another option if you are willing to tie up your money for a longer period. Some of the major fixed rate bonds offered by banks and building societies pay up to 2.4% for a two-year fixed rate or 2.6% for a five-year fixed rate.

c) Premium Bonds

Premium bonds are a type of National Savings & Investments (NS&I) savings product, held by over 21 million people in the UK. Instead of paying interest, Premium Bonds offer bondholders the chance to win prizes ranging from £25 to £1million each month tax-free. You can withdraw your money at any time by cashing in all or part of your bonds.

According to the NS&I, there are 34,500 to one odds of winning a prize per £1 bond, which equates to an interest rate of 1.0%. This rate is currently just below major easy-to-access savings accounts, although there’s no guarantee you’ll win a prize.

Property income

Investing in real estate can generate substantial passive income, whether it’s long-term rentals or short-term vacation rentals. However, this involves a significant initial investment, as well as ongoing maintenance and management of the property.

Homeowners have faced an increasingly difficult environment in the UK, with the end of mortgage interest tax relief in 2020, rising interest rates and the recent requirement for a certificate of minimum energy performance for rental properties.

The property yield is used as an empirical measure to estimate the annual property yield and is calculated as the annual rent divided by the purchase price. According to property developer SevenCapital, the average rental yield in the UK is 3.6% (as of April 2022).

However, the yield varies by region, with SevenCapital reporting that average property yields in 2021 ranged from 2.9% in London to 4.4% in the North West. Although vacation rentals may offer higher potential returns, this depends on the number of weeks per year the property is rented out and additional management fees.

In summary, the return to property income is low, since costs such as mortgage interest and maintenance must be deducted from rental income. However, rental properties can also provide additional capital over a longer term period.

Final Thoughts

Although significant capital is required to invest in real estate, it is possible to generate passive income by investing small amounts of money in savings accounts and stock investments.

As with any investment, you need to consider the level of risk associated with the product and whether you are able to absorb any losses. In most cases, income tax will be payable on passive income, unless you hold investments in a tax-advantaged package such as an ISA.

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