It’s possible to invest in dividend stocks to create a sustainable passive income. With consistency and good decision making it should be within reach of anyone. Yet so few people even try.
To generate a passive income of £500 a month, I would need to build an investment pot worth around £150,000. Then, if I can achieve an average dividend yield of 4% on my investments, it would be possible to earn £500 a month without doing anything further.
If I invested the maximum Stocks and Shares ISA allowance each year (£20,000), even without any capital and income growth, it would take less than eight years to reach this goal. It ought to be possible to achieve this passive income much more quickly though and here’s how.
Finding dividend growth shares to fuel passive income
The first step of my plan for passive income is to invest largely in dividend growth stocks. I want to invest in UK shares that are able to grow profits and their dividends year after year, even when the market struggles.
MacFarlane, the packaging manufacturer and distributor is one of only a few companies that has consistently met these criteria (although it isn’t guaranteed to do so in future, of course). Other possible options that have in some years seen profits dip but have a good dividend growth track record are FTSE 100 companies Ashtead and National Grid.
Investing in UK shares with resilient business models
To make sure a company is able to grow profits and dividends sustainably and to reduce the costs of buying and selling shares too frequently, I’ll focus on UK shares with business models that should continue to prosper many years into the future.
This isn’t necessarily about trying to pick companies that could double their share prices overnight or searching for the ‘next big thing’. It simply means I want to screen out companies, and indeed industries, that could really see their share prices decline in the coming years.
I’m not looking to be contrarian in my search for a passive income portfolio. I want to buy good companies, at a good price, with a decent dividend yield and providing dividend growth.
Once that’s been done, it’s important to reinvest my dividends. This is how compounding works. By reinvesting dividends it’s possible to get a snowball that builds momentum and grows and grows. Consider this. A £4,000 investment in the FTSE 100 in 1987 with dividends taken out, rather than reinvested, would now be worth around £32,000 (excluding fees). Seems impressive.
And yet with dividend reinvestment, it would be worth more than £59,000 (excluding fees) had it matched the total return from the index. That clearly illustrates the benefits of compounding.
Another example is how Warren Buffett’s wealth has grown massively in recent years. This is the snowball in action.
So, achieving passive income from investing in dividend shares is doable. I certainly plan to have a passive income portfolio, which will have UK shares in it that I hope will do well for many years and provide dividend growth. And most importantly of all, those dividends will be reinvested.
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Andy Ross owns no share mnetioned. The Motley Fool UK has recommended National Grid. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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