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I'm a big fan of the Financial Independence and Retire Early (FIRE) movement. The idea of generating a sustainable passive income to supplement and hopefully replace my nine to five job sounds ideal.
Of course, it takes a lot of hard work, discipline, and good luck to achieve another source of income. I believe investing in high-quality British shares is one of the most feasible ways to achieve this.
Here are three things investors should consider when generating passive income for the future.
<h2 class="wp-block-heading" id="h-investing-in-the-right-stocks“>Invest in the right stocks
Choosing the right investments is key. Personally, I prefer stocks with high dividend yields, as payout levels tend to be relatively sticky. Company boards tend to avoid cutting dividends substantially, when they can, to avoid sending the wrong signal to investors.
There are plenty of high-performing stocks in Footsie. An example is Legal and general (LSE: LGEN), which is currently returning an impressive 8.7%.
This is well above the Footsie average of around 3.5% and one of the highest within the UK large cap index. The firm is a major player in the UK asset management industry and could benefit from pension consolidations as it looks to grow assets under management and associated fees.
While high performing, Legal & General is not for me at the moment. The company's dividend coverage ratio of 0.9 indicates that its earnings do not cover its dividends, and that raises questions about future payments. Price-to-earnings (P/E) ratio above 40 is another concern for me.
To do this, it is important to be aware of the dividend value trap. This happens when investors buy a stock for its high yield, but in reality the stock price is falling due to the low yield, making the yield appear artificially high.
While I'm all for dividend payers that can increase the future value of my portfolio, Legal & General is not one for me. There are several other Footsie stocks with high yields, including GSKwhich I am considering.
Develop sustainable savings habits
Investing in stocks like Legal & General and other dividend stocks is only possible with cash to invest. Investors who can develop healthy long-term savings habits are actually in a position to generate considerable passive income.
These habits are also useful when looking for bargains. Investors who have cash available to buy when others sell could potentially invest in some cheap stocks and boost their long-term returns.
Have an emergency fund
This is all well and good, but investors can easily get caught up in market movements. The stock market tends to be cyclical, so a recession could affect the value of a portfolio at the same time people need more cash.
Clearly, it is best to avoid selling at the bottom. One of the best ways for investors to protect themselves is to create an emergency or emergency fund to cover a reasonable amount of expenses.
That amount will vary for each person, but I tend to keep three to six months of expenses saved. By doing this, while choosing the right investments and consistent savings habits, I hope to avoid fire sales and generate long-term passive income.
