If you're lucky enough to have $10,000 or more in surplus savings at your disposal, you might be wondering what the best thing to do with it is. Of course, you want to make sure you have enough money set aside in a rainy day fund in case you are hit with some unexpected cost or reduction in income. But if that's already the case, you might want to think about investing your cash into investments that generate passive income.

At the start of 2025, one might have considered just leaving that $10,000 in a savings account or term deposit and receiving passive income in the form of interest. But after what has now been three interest rate cuts this year so far, that option is fast becoming less attractive.

So what's the alternative? Investing in ASX dividend shares, of course. Dividend shares are one of the assets to use if you want to build up a stable source of passive income.

There are obviously dozens, if not hundreds, of individual ASX dividend shares to choose from, which can make starting an investing journey quite daunting.

However, if you have $10,000 or a similar amount and wish to start, it might be a good idea to start with one diversified investment.

There are many options to choose from. The best choices for a beginner investor, in my view anyway, are index funds and listed investment companies (LICs).

Choosing a passive income investment for $10,000

These investments group a selection of underlying shares within a single investment. For example, an ASX index fund like the iShares Core S&P/ASX 200 ETF (ASX: IOZ) holds the 200 largest stocks on our share market.

An index fund like this would be a good choice. Most of the largest 200 companies on the ASX pay out dividends. By grouping them all together, investors can achieve an average of these dividends. The IOZ index fund currently has a trailing dividend yield of roughly 3.4% at current pricing. That's enough to start a substantial stream of passive income right off the bat.

If you are after a bit more income up front, you can opt instead for a dividend-focused exchange-traded fund (ETF) like the Vanguard Australian Shares High Yield ETF (ASX: VHY). This ETF works similarly to IOZ, but rather than holding the largest 200 companies on the ASX, it holds a smaller portfolio of stocks selected for their dividend history and potential.

LICs are an alternative to index funds. Rather than blindly tracking an index, LICs function as companies that manage an underlying portfolio of diverse stocks on behalf of shareholders.

Two prominent examples are Australian Foundation Investment Co Ltd (ASX: AFI) and Argo Investments Ltd (ASX: ARG). Both of these LICS have been around for decades. Since their inception, both have developed well-earned reputations as conservative wealth managers, investing in sound companies for the benefit of their long-term investors. Both pay out generous passive income too, in the form of fully franked dividends. AFIC is currently trading on a dividend yield of 3.57%, while Argo is closer to 4%.

Foolish Takeaway

Whether you opt for an index fund or an LIC for your first $10,000 investment, you are taking a decisive first step in starting a source of passive income. If you just set these funds and forget about them, while reinvesting any and all dividends you receive, you will have a strong and growing source of passive income before you know it.