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Generating passive income from a pile of cash has been easy in recent years. With UK interest rates at high levels, sticking the money in a high-interest savings account was the easy option.
The financial landscape’s now changing however. With interest rates falling, savings accounts are not the income vehicles they were.
The good news is that it’s still possible to pick up healthy levels of income with dividend stocks. Here’s a look at how these stocks can provide investors with regular cash flow and why they could deliver attractive returns as interest rates fall.
A small slice of company profits
Dividend stocks pay investors cash distributions on a regular basis out of company profits. As a part-owner of the underlying business (a shareholder), you get a small slice of the profits in the form of a cash payout.
The level of income on offer (the dividend yield) varies from company to company. But on the London Stock Exchange today, there are many dividend stocks with yields in the 5-8% range. So it’s possible to create a nice little passive income stream with these stocks. And if held in a Stocks and Shares ISA, this income can be tax-free.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Pros and cons
Now, like every asset class, dividend stocks have their pros and cons. On the downside, they’re riskier than cash savings accounts. That’s because the value of your initial investment can fall (if a company’s share price declines).
One big positive however, is that they offer two potential sources of return. Not only can you pick up regular income but you can also benefit from share price increases.
If you own a stock with a yield of 5% and its share price jumps 10%, your total return is 15%. That kind of return is far better than those on offer from cash savings accounts.
Interest rate boost
It’s worth noting that the share prices of dividend stocks often do well when interest rates are falling. That’s because their yields become more attractive as rates decline, leading to more investor interest (higher demand pushes share prices up).
So they could provide attractive returns if UK interest rates continue to fall. I’ll point out that economists expect the Bank of England to cut rates again in August.
A stock to consider
In terms of investment ideas, one dividend stock I like the look of today is HSBC (LSE: HSBA). It’s forecast to pay out about 67 US cents per share in dividends for the 2025 financial year. That puts its yield at about 5.5%.
Beyond the attractive yield, this stock has several things going for it. For starters, the valuation is relatively low. Currently, HSBC trades on a forward-looking price-to-earnings (P/E) ratio of just 9.1 (well below the market average).
Secondly, the bank’s buying back its own shares. Buybacks can boost earnings per share (EPS). Higher EPS, in turn, can lead to share price appreciation.
Third, the company has a fair bit of long-term potential. Today, HSBC’s heavily focused on growing its operations in Asia. This is an area of the world where banking has a long growth runway.
Of course, the banking industry can experience turbulence at times. So with this stock, investors need to be prepared for share price volatility every now and then. However, I think it’s worth considering.
