The ASX share market could be the most bountiful place to generate a good yield from passive investment income.
Term deposits are now offering a better interest rate. But, while they do offer protection, I think a downside is that they can't organically generate a higher return. Term deposits don't generate profit that can grow.
But, with businesses, they can grow profit. Companies can decide to pay out some of the annual profit each year as a dividend and use the rest to generate more growth.
Different businesses have different yields. Some yields are so large that they can generate a lot of passive income from a relatively small investment.
Generate $140 every month
There are very few investments that pay dividends every single month. A lot of ASX dividend shares pay dividends every six months or every three months.
But, we can think of $140 per month in annual terms – it's $1,680 each year.
I'm not about to say that earning $1,680 from a $5,000 investment is a good idea, or even possible. That would represent a 33.6% dividend yield.
There's a more realistic and sustainable way.
Let's imagine we invest in a diversified portfolio of ASX dividend shares with an average dividend yield of 5%. That would be an annual passive income of $250. Re-investing those dividends into more ASX dividend shares with a 5% dividend yield would make an extra $12.50 of dividends, meaning $262.50.
Continuing re-investing those dividends every year means the power of compounding can really boost the annual income. If the dividends from the businesses themselves don't grow, then after five years it could be just over $300 of annual dividends, in 10 years it's $388 of dividends, after 20 years it's $632 of annual dividends and after 40 years it would be around $1,680.
But, let's keep in mind that many businesses do grow their dividends. It's impossible to say what the coming decades have in store. If a business pays a dividend yield of 5%, we re-invest those dividends and it grows the dividend by 5% each year, which means the annual dividends would increase by around 10% per annum.
So, if we assume a portfolio of ASX dividend shares grows their dividend by 5% per annum, we re-invest the dividends (and also acknowledge that the cost of buying more shares rises over time in this calculation), we could receive over $11,000 of annual dividends each year after 40 years, just from that initial $5,000 investment.
Foolish takeaway
I think that ASX dividend shares like Wesfarmers Ltd (ASX: WES) are a great source of passive income. There are loads of resources on The Motley Fool website about which ASX dividend shares could be good investments to own.
