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How to earn passive income in the stock market

Karl Loomes
·3-min read
Couple relaxing on a beach in front of a sunset
Couple relaxing on a beach in front of a sunset

There are many ways to earn passive income. From having your own business to vlogging, making ongoing money from one initial investment of time or money is what many aspire to. While these methods all generate plenty of hits when you Google them, I would argue that investing is one of the most accessible and easy ways to earn passive income for most people.

It pays dividends to go with shares

The way you earn passive income in the stock market is through investing in shares that pay dividends. We often forget, but buying shares in a company in effect makes you a part owner, albeit a very small part. Most of the time shares even come with voting rights to allow you to have a say at the annual general meeting (AGM).

What interests us though, is that a company’s stock often grants you the right to share directly in the company’s profits. Firms do this through the distribution of dividends.

All shares are not created equal of course. Firstly, not all companies pay dividends. Those that do, pay different amounts. This has an interesting consequence though, that can help when trying to earn passive income through shares.

Dividends/share price = dividend yield

This short formula can be key to locking in good returns, allowing us to earn a decent passive income from dividend shares.

Companies pay dividends on a pence-per-share basis. Every share you own gets X pence, usually divided across a few payments in the year. Most of the time you, however, you see dividends measured as a percentage.

This percentage, called its yield, is effectively how much return you can expect given the current share price. If a share costs £1 and the company pays 10p per share in dividends, the yield is 10%.

Of course, share prices fluctuate. If you bought the share at £1 you would lock in this 10% return. However, if you buy at £2 you would only get a 5% yield on your investment. The opposite, of course, also holds true. When a share price is low, higher dividend yields can be found.

Earn good passive income in the stock market

This is the key to maximising how much you earn as passive income in the stock market. If you invest your money when a dividend-paying company has a dip in its share price, you lock in a high percentage return.

Of course there are things to watch out for. Firstly, buying shares, even for passive income, you need to be aware of capital gains and losses. Share prices go up and down, so you need to make sure the low share price you find is not a sign of real problems. Good advice helps here.

As a rule, go for solid, well-known companies like those found in the FTSE 100. Look for shares that have a consistent history of paying dividends. You may earn some money this year, but ideally you want a passive income source to continue for many more.

Also plan on investing for the medium to long term – at least five years. This is usually long enough for short-term fluctuation to fade. With some sensible decisions and a little help, the stock market can be the quickest way for most of us to earn some passive income.

The post How to earn passive income in the stock market appeared first on The Motley Fool UK.

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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.

Motley Fool UK 2020