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Over the past few months, we have seen the interest rates offered by cash savings accounts increase. As good as it is for anyone with money in the bank, I would always prioritize buying dividend stocks for the passive income they provide.
Money is not trash…
Let me be clear. By saying that I prefer dividends to cash, I am not ignoring the advantages that come from some of the latter.
Simply put, cash provides a degree of security that other assets cannot. When I go to bed at night, I can be sure that the amount in my savings account will be the same as it was the night before.
This fact is deeply reassuring given the difficult economic times in which we live. If an unexpected bill hits my doormat today, a cash reserve will allow me to pay it. That’s why I would never think of investing a dime if I didn’t already have a few months of spending in place.
Despite this, it is also a fact that any money left in the bank will still struggle to retain its value, due to rampant inflation.
Of course, the recent cap on energy bills announced by Liz Truss will help to reduce the damage somewhat. However, I don’t think we are about to see this all-important figure fall quickly to the Bank of England’s 2% target.
This means that even the highest paying savings account – currently offering 2.5% – isn’t so great in the grand scheme of things. It’s fine for an “emergency pot”, but that’s about it.
Luckily, that’s where dividend stocks come in.
… but dividend stocks could make me rich
Right now, it’s pretty easy to find stocks that earn two or three times more than a savings account. Some companies have forecast dividend yields even higher than that! At the time of this writing, home builder Khaki and mining company Rio Tinto benefit from double-digit cash returns.
It’s getting better. Assuming I already have this emergency cash fund in place, the passive income I receive can then be reinvested into the market at a time when many companies are trading much lower than they once were. . Theoretically, the more shares I accumulate, the more passive income I should receive over time.
Spread over many years and through compounding, it’s not hard to imagine how this virtuous cycle could lead to a big nest egg and possibly early retirement.
Despite their greater appeal to fools like me compared to holding cash, dividend stocks are not without risk. Companies can, and sometimes do, take their returns away from investors if trading suffers. In fact, we could see this happening more and more frequently in the coming months as a recession sets in.
Even if most companies don’t cut, their stock prices could continue to fall. So I could still record a capital loss on paper for a while, regardless of the income I receive.
That’s why it makes sense for me to have a bunch of passive income-generating stocks rather than just one or two. Moreover, these should come from several sectors. It is extremely risky to buy stocks of, say, home building companies and nothing else, because I only depend on the performance of one sector.
And that’s just not the stupid way.