Passive Income: The Good, the Bad, and the Ugly

Stocks like Enbridge Inc (TSX:ENB) can provide steady passive income, but there are serious risks to consider as well.

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Passive income: everybody wants it, but so few get it. While it’s pretty common for Canadians to get passive income in retirement in the form of pensions, not many people get passive income when they’re still working. That’s unfortunate, because passive income can provide you with the cushion you need to survive a period of unemployment or even retire early.

Certainly, having large amounts of passive income coming in is a good thing. However, there are a lot of “ifs, ands, and buts” with this topic. In general, it’s easy to get very small amounts of passive income coming in — you can get a few dollars a year coming in by investing $100 into dividend stocks. However, it’s hard to get an amount coming in that you’ll actually be able to live off of.

In this article, I will explore the good, the bad, and the ugly about dividend stocks and passive income, so you can decide if pursuing this path is right for you.

The good: Passive income can pay for your retirement

The good thing about passive dividend income is that if you invest diligently over a lifetime, you can use it to pay for your retirement. If you have the ability to save $20,000 per year, then you can save $600,000 in the course of three decades. If markets perform reasonably well over your investing lifetime, you can grow that amount to $2 million. With $2 million and a 3% dividend yield, you can get $60,000 back each year in passive income.

That’s not to say that you need $2 million to get a large amount of passive income coming in. You can actually get pretty significant amounts of passive income with just a few hundred thousand dollars. You do that by investing in stocks that have higher yields than average.

Consider a stock like Enbridge (TSX:ENB). At today’s prices, ENB stock yields 6.63%. The stock has sometimes been criticized for having an unsustainable dividend, as it pays more in dividends than it earns in free cash flow. However, it has been raising its dividend consistently for more than 25 years without issues, so its dividend track record is excellent.

Assuming that ENB keeps up its dividend track record going forward, you’ll be able to get $66,300 back in dividends on a $1 million position. With $500,000, you could get $33,150 back each year. That’s a decent little income supplement right there, and it could grow over time. Over the last 28 years, ENB has grown its dividend by 10.5% per year. If it can keep up that growth, then the yield on cost will grow, contributing significantly to an investor’s cash flow in retirement.

The bad: Passive income is sometimes unreliable

Previously, we looked at Enbridge as an example of a stock that has provided pretty regular passive income for its investors. Now, we can look at a counter-example:

Algonquin Power & Utilities. This company missed badly on its third-quarter earnings, which saw profits decline severely. Because it would have paid more in dividends than it earned in profit had it continued its dividend, it cut the payout by 40%. Investors saw every $100 worth of dividends they thought they’d get from AQN turn into $60 overnight.

The ugly: You have to save a lot of money to get a significant amount of passive income coming in

Finally, here’s the ugly truth about passive income: you need to save a lot to get a lot of it coming in.

Earlier, I showed that with a stock like Enbridge, you can get $66,000 in passive income with much less money invested than if you’d invested at the market yield. That’s a true fact, but it remains the case that you need to invest $1 million to get a $66,300 income coming in from Enbridge stock. Ultimately, you’ll need to invest a lot of money to get significant passive income coming in. Over the course of several decades, it can be done.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy.

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