There are a multitude of ways to make passive income through investing. You can buy a rental property, invest in fixed-income instruments like bonds, sell options like covered calls, or buy dividend stocks. Each method has its benefits and drawbacks, including the level of investment and activity required to generate passive income and the risk profile.
Of all those options, investing in dividend stocks is one of the most powerful ways to generate passive income. That's because many companies increase their dividends at least once each year. As a result, you can collect a steadily rising income stream, which isn't as easy to achieve with those other strategies. Here are two examples of the power of investing in dividend stocks for passive income.
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Warren Buffett's dividend income gem
Warren Buffett's company, Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B), has famously avoided paying dividends over the years, preferring to retain its earnings and reinvest that cash. One thing Buffett's company likes to invest in is dividend stocks. Berkshire holds several of them in its investment portfolio. Among the most notable is Coca-Cola (KO -0.54%).
The beverage giant is a dividend machine. It has raised its payment for 63 straight years, including by 5.2% in February. It paid its investors $8.4 billion in dividends last year and over $93 billion since 2010.
Buffett's company has collected dividend income from Coca-Cola for over three decades. Berkshire invested about $1.3 billion in the beverage stock between 1988 and 1994. Today, those shares are worth a staggering $28.4 billion. On top of that, Berkshire has collected an estimated $11.5 billion in dividend income over the years from the stock. The 400 million shares it owns today entitle it to receive over $800 million in dividend income each year, up from $75 million annually in 1994. That gives Berkshire a yield on cost of over 60%. Berkshire's purchase of Coca-Cola showcases the power of dividend stocks to produce passive income if you hold them over the long term.
Living up to its name
Realty Income (O -0.56%) has built a brand around providing its investors with passive income. The real estate investment trust (REIT) has a clear mission: "To invest in people and places to deliver dependable monthly dividends that increase over time." It's so focused on that income mission that the REIT calls itself The Monthly Dividend Company.
Realty Income has certainly lived up to that name over the years. It has paid 659 consecutive monthly dividends since its formation. The REIT has increased its payout 130 times since its public market listing in 1994, including for the last 110 quarters in a row. Overall, it has grown its payout at a 4.3% compound annual rate over the past three decades.
That dividend growth has really added up over the years. Here's a look at how much dividend income an investor would have earned from this REIT if they bought 1,000 shares a decade ago:
Image source: Realty Income.
As that graphic shows, an investor who purchased 1,000 shares of the REIT a decade ago would have collected $2,201 in dividend income during their first year of ownership. That's a 4.6% yield on their initial cost ($47,710). The REIT has increased its dividend by 46% over the past decade. Because of that, the investor is now collecting $3,222 of dividend income each year from their initial investment (a 6.8% yield on their cost). Further, they've accumulated a total of $30,159 in dividend income from their investment over the past decade (63% of their original investment). They also hold shares that are now worth 22% more than their initial investment.
The REIT's income stream will likely continue to rise in the future as it grows its portfolio of income-generating real estate.
Powerful ways to produce passive income
Investing in dividend stocks is a powerful way to generate passive income. The best ones steadily increase their dividends. That enables their investors to collect more passive income each year without having to do more work or invest more money. Because of that, if you want to generate passive income, you should own some high-quality dividend stocks like Coca-Cola and Realty Income.
