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Passive income plans come in all sorts of shapes and sizes. One that is old but potentially very lucrative is buying shares in the hope they will pay dividends.
Such an approach can have both pros and cons. Here are a couple of each.
Pro: it’s a genuinely passive income approach
Some so-called passive income plans seem anything but passive to me in practice. For example, they can involve all the initial legwork of setting up a business even if, supposedly, it will effectively run itself in future.
By contrast, it is possible to buy shares, then sit back and earn any dividends they pay. That is what I regard as genuinely passive.
Con: dividends aren’t guaranteed
If you put money into a Cash ISA, a fixed passive income is almost guaranteed. I say almost because there may be exceptional circumstances, such as a run on a bank as happened at Northern Rock less than 20 years ago.
Even then though, depositors are ordinarily automatically insured up to a certain level, so even though the promised returns may not materialise, their capital ought to be safe within that limit.
Dividends, by contrast, can move around and often do. Some go up, some go down, some disappear altogether, whether temporarily or forever.
A properly diversified portfolio of dividend shares can help reduce the possible impact of that risk on passive income streams, but it remains a risk.
Pro: participate in the potential gains of a brilliantly-performing business
Looking at that comparison from another perspective though, fixed interest rate investments tend to have a maximum possible return.
Compare that to a share like M&G (LSE: MNG). The share yields 6.8%, meaning that someone who invests £100 today will hopefully earn £6.80 in passive income each year.
In fact, they could earn more, as the FTSE 100 asset manager aims to grow its dividend per share annually and has done so over the past few years (though, of course, that is never guaranteed).
Not only that, but the share price has grown 38% over the past five years.
So £100 invested in May 2021 would now be worth £138, even before taking into account passive income from dividends.
Owning shares in a business that does well can potentially therefore help someone earn passive income — and also capital gains.
M&G has a client base in the millions, multinational footprint and deep asset management experience I think can help it.
Con: money’s at risk
Again though, there is a flipside. Like any business, M&G faces risks. For example, current stock market turbulence could see clients pull money from its funds. If that happens, earnings might fall – and that may be bad news for the dividend.
Money in the bank, as I explained above, is typically protected by certain industry-backed guarantees like the Financial Services Compensation Scheme. Dividend shares offer a different risk profile. Not only are dividends not guaranteed, but the shares also carry the risk of capital loss. Then again, as I demonstrated with M&G, they carry the potential for capital gain.
In fact, I see M&G as a dividend share for investors to consider right now.
This story originally appeared on Motley Fool
