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A passive income stream can make a big difference to your retirement. As billionaire investor Warren Buffett once said, if you don’t find a way to make money while you sleep, you’ll work until you die.
Bonds can give investors a relatively reliable second income. But I think for investors who can handle the extra risk, stocks can put them in the passive income fast lane.
Bonds
Bonds are one of the safest ways of generating passive income. As long as the UK government doesn’t default on its obligations, the returns are more or less guaranteed.
Exactly how much you need to invest in bonds to earn £1,000 a month – or £12,000 a year – in retirement depends on when you want to give up work.
Right now, a 10-year government bond comes with a 4.54% yield. At that rate, someone would need to invest around £1,900 a month to earn £12,000 a year in income within the next decade.
For someone with a longer-term view, a 30-year government bond comes with a 5.35% coupon. At that rate, £275 each month is enough to build something returning £1,000 a month by 2055.
Bond yields however, can change as prices fluctuate and this means there’s no guarantee of being able to reinvest at that rate. And there’s another issue with bonds: inflation.
A longer time horizon means fixed cash returns are likely to be worth less than they are right now. So I think long-term passive income investors might want to consider other options.
Stocks
For investors aiming for better returns, stocks are an interesting alternative to bonds. The risks are higher, but the potential rewards are also greater to make up for this.
One example is Supermarket Income REIT (LSE:SUPR). The firm’s a real estate investment trust (REIT) that leases a portfolio of retail properties to the likes of Tesco and Sainsbury.
REITs often come with big dividend yields and at 7.75%, this one’s no exception. And with its rental contracts linked to inflation, it looks to offer the kind of protection that bonds don’t.
The Weighted Average Lease Term (WAULT) is around 11 years, suggesting that this income is likely to come in for a long time. But there are risks to consider.
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One is the potential for higher interest rates. The firm’s average debt maturity is shorter than its leases, meaning it won’t be able to raise rents to offset higher financing costs.
This is something to keep in mind. But I think investors should seriously consider a stock with a 7.75% yield that rises with inflation, a rise that means it could help offset the impact of ever-higher prices.
Getting in the fast lane
REITs are sometimes seen as an alternative to bonds. I can see why this is, but there are some important differences – one being that REIT dividends can go up in ways bond returns don’t.
A 7.75% average annual return lets someone turn £950 a month into a £12,000 a year in passive income. And for someone with 30 years, £150 a month is more than enough to achieve this.
As with bonds, dividend yields can change with market fluctuations. But for long-term investors looking to maximise their returns, I think the stock market is the place to be.
