Suppose I had a choice between: (i) £1,000 cash, (ii) £34.50 per year in passive income for 10 years followed by £1,000, or (iii) an unspecified return for an unspecified time. Which would I choose?
Investing in the stock market involves taking the third option. If I preferred £1,000 in cash, I probably wouldn’t invest in anything and if I thought the second option was best, I’d invest in bonds.
Stock market investing
Investing in the stock market involves buying shares in businesses. Some of those distribute the money they make to their shareholders in the form of dividends, or share buybacks.
The trouble is, there’s no way of knowing with certainty how much money a company will make. That’s why the amount an investor will make in passive income by owning stocks is unspecified.
There’s also no way of knowing how long the company will keep paying dividends for, or what the share price will be 10 years from now. Future share prices are arguably even harder to predict than dividends.
It’s therefore difficult to choose the unspecified return over the £34.50 (what I’d get from a 10-year UK government bond at today’s prices). So why would anyone looking for passive income invest in stocks?
Risk and uncertainty
The main reason is because I don’t think the future is completely uncertain. It’s impossible to be 100% sure about what the return on a stock will be, but it’s possible to know something.
For example, take Rightmove. I own this stock in my portfolio because I think I know enough about the company to be confident its shares will be a better investment over the next 10 years than a bond.
I have this view because I know certain things about the business. I know how it generates cash, what its costs are, how much debt it has, and what makes it difficult for competitors to disrupt.
None of this guarantees that investing in Rightmove shares will turn out better than a bond. Investing in shares is always risky, but I think there’s reason to believe buying the stock is a good idea.
How to invest in shares
When I invest in the stock market, it’s really important to stick to companies I can understand. Otherwise, I’m buying something with an unspecified return that might be better or worse than a bond.
As an example, I don’t have a good idea about how to estimate the prospects for pharmaceutical drugs. As such, I’m not buying shares in AstraZeneca or GSK at today’s prices.
I wouldn’t rule out doing so in the future – something might happen that means these stocks are obviously good investments. But I don’t think I’m in a position to judge this accurately enough right now.
Passive income in the stock market is never guaranteed. But there are sometimes opportunities for investors like me to spot better returns than bonds are offering. And this is the time to buy stocks.
The post Is the stock market the best place to earn passive income? appeared first on The Motley Fool UK.
We think earning passive income has never been easier
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Get your free passive income stock pick
setButtonColorDefaults(“#5FA85D”, ‘background’, ‘#5FA85D’);
setButtonColorDefaults(“#43A24A”, ‘border-color’, ‘#43A24A’);
setButtonColorDefaults(“#FFFFFF”, ‘color’, ‘#FFFFFF’);
})()
More reading
Turning a £20k ISA into a second income worth £1,500 a year!
How to lose money in the stock market, according to Warren Buffett
Could FTSE 100 banks supercharge a £20,000 Stocks and Shares ISA?
2 cheap FTSE 250 dividend shares! Here’s why I’d buy them this April
Yields of up to 6.6%! 2 dividend stocks I’d buy to hold for 10 years
Stephen Wright has positions in Rightmove Plc. The Motley Fool UK has recommended GSK and Rightmove Plc. 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.