The stock market is one of the easiest and most affordable places where an investor can earn passive income. Stocks are liquid, so they are easy to buy and sell. Likewise, most discount brokerage commission rates are very affordable (either free or below $10).
The nice thing with stocks is you don’t have to plough all your money into one asset. You can build a diversified portfolio with several different stocks that each yield income. As a result, you can hedge your bets and ensure that your sources of income come from a variety of sectors and industries.
Pitfalls to avoid when investing for passive income
One mistake beginners often make when looking for passive income is to just buy stocks with the highest yield. Who doesn’t want to earn a 7-10% cash return on their capital?
Yet, there are often reasons why a stock’s yield is extremely elevated. It may be a bad balance sheet, a weakening business outlook, or even concerns about the viability of the dividend itself. Often, a rising yield is related to a declining stock price. You don’t want to buy a falling knife.
Look for total returns and best-in-class companies
What’s the point of collecting a high yield if that stock is rapidly declining, or if that dividend is at risk of being cut?
One of the best ways to avoid this is to build a dividend stock portfolio for its total returns. The best dividend stocks are those that regularly raise their dividends because their earnings/cash flows are likewise rising. With these stocks, you get the combination of attractive income and steady capital appreciation.
If you are looking for some ideas to build a passive-income portfolio, here is how I would structure it.
Utilities for safe passive income
A utility stock like Fortis (TSX:FTS) can be great structural ballast in a portfolio. It doesn’t grow much (about 4-6% per year), but it has a very stable, regulated electricity and natural gas transmission/distribution business.
Earnings don’t fluctuate too much from one year to the next. You can hold this stock through a variety of market cycles, and it is likely to deliver a mid- to high single-digit total return.
It only yields 3.5% today. However, it has a 52-year dividend-growth track record that is not matched by any other stock in Canada.
Real estate
Real estate stocks are especially nice if you want passive income on a monthly basis. Real estate investment trusts earn rents monthly, and they distribute a majority of that income back to unitholders monthly.
Granite REIT (TSX:GRT.UN) is a defensive Canadian REIT. Granite operates institutional-grade logistics, manufacturing, and warehousing properties across Canada, the U.S., and Europe. It has long-term leases to high-quality tenants. It yields 4.4% but has raised its distribution for 15 consecutive years.
Financials
Canada is very well-known for its Big Six banks. Every Canadian investor should have some exposure. Royal Bank of Canada (TSX:RY) is the largest and arguably best bank.
While it trades at a premium (and a lower yield of 3%), it has a top franchise in Canada and a great balance sheet. Banks can be economically sensitive, so position size accordingly. I prefer to own the best in the industry for stable, growing passive income.
Energy
Energy stocks are cyclical and can be a little riskier. However, there are a few energy stocks that are very well-managed. Their dividend track records are exceptional. Canadian Natural Resources (TSX:CNQ) is in a league of its own. It has grown its dividend for 25 years by a 21% compounded annual rate.
The company produces energy with factory-like efficiency. It has a strong balance sheet, great profitability, and decades of energy reserves. If you want passive income, own the best of the best in the industry (like CNQ), and you stand to do very well over the long term.
