New Investors: The 2 Best Options To Earn Regular Passive Income!

If you are new to investing and want to earn passive income, there are two ways to do it:

1. Dividends/Interest.
2. Covered calls.

Which passive income source is most suitable for your investment portfolio depends on your investment objective and risk profile. Dividends and interest are cash payments made by issuers of securities (stocks or bonds respectively) in exchange for holding their securities – we use the term ‘dividend’ in relation to stocks and ‘interest’ in relation to bonds. A stock with a consistent dividend payout can increase your income steadily, but slowly.

Covered calls are options that pay you a certain amount of money, called a premium, to agree to sell your stock at a specified price in the future. Premium earnings can be higher and make your income grow faster, but are less predictable.

Let’s examine these two main ways you can generate passive income from your investments and compare their strengths and weaknesses.

Dividends/Interest

Dividends and interest are regular cash payments that you receive from investments. Dividends from stocks are typically paid once a quarter; Interest on bonds is often paid twice a year. There are also bonds that pay you all of your returns at the end of the holding period. Unlike stocks, bonds have “maturity dates” when everything is paid back to you. A common bond-like investment is a GIC, an instrument that pays you back a little more than you put in after a few months or years.

Dividend stocks typically pay more than bonds. Currently the Toronto Dominion Bank (TSX:TD)(NYSE:TD) stock is yielding 4.12%, which is a much higher yield than the average GIC. There are GICs from fair bench that yield 5% or more but have very long maturities. Dividend stocks typically wipe out the returns on short-term GICs. Plus, dividend stocks offer growth. When a company is doing well, its stock is likely to rise, and it may also increase its dividend. TD Bank, for example, has increased its dividend by about 9% per year over the past five years. With a 9% growth rate, your payout will double after eight years.

Covered calls

Another way to earn passive income from your investments is to write covered calls. A covered call is a type of option where you own a stock and agree to sell it to someone in the future if it hits a predetermined price. The buyer pays you a small fee, called a premium, for agreeing to sell the stock to them. Let’s say you own 100 TD shares and decide to write covered calls with a $100 strike price (ie the target price at which you must sell). When the markets offer a $1 to $100 option premium on TD stock, you get $100 up front. If TD stock goes to $100, you will have to sell all of your shares. If not, simply keep the fee and collect passive income in the process. This strategy is a bit complex and not for beginners, but you can access it through funds like this BMO Canadian High Dividend Covered Call ETF, where a team of professionals implements the strategy for you.

Stupid take away

Of the top two ways to earn passive income in the stock market, collecting dividends is definitely the easiest. You can simply buy a diversified, broad market index fund and receive cash payouts. The returns from such a strategy are not sky high, but are usually positive. Writing covered calls is a more difficult strategy, but it can be lucrative. If you are a beginner, you can start buying a fund that uses this options strategy.