Making a passive income large enough to give up work is likely to be a major ambition for many people.
Through buying a diverse range of high-quality dividend shares today, it is possible to obtain a worthwhile income alongside generous capital returns.
Although holding some cash means lower returns in the short run, it can act as a buffer to protect an investor from market downturns such as the 2020 stock market crash.
Buying dividend shares for a passive income
I think dividend shares offer the most attractive passive income among mainstream assets at the present time. Low interest rates and high property prices mean that the income returns of savings, bonds and property are relatively low. As such, for investors who have capital available to invest today and require an income right now, dividend stocks seem to me to be a valid choice as part of a basket of investments.
They could also provide strong capital growth in the long run. This makes them attractive for investors who are seeking to build a portfolio from which to obtain an income at some point in the future. The high yields of many income shares suggest that they offer good value for money at the present time, which could translate into capital growth. Meanwhile, their appeal versus other assets could lead to growing demand that pushes their valuations higher in the long run. This may lead to a larger retirement portfolio that makes it easier to generate a passive income in older age.
Diversifying among dividend stocks
Whether an investor is seeking a passive income today or in future, diversifying among a wide range of dividend shares is an important consideration. The future outlook for the economy is very uncertain at the present time. Some companies, industries and regions could be hit harder by factors such as political change and the future path of the coronavirus pandemic.
Therefore, it makes sense to have a broad range of stocks from a variety of industries and locations in a portfolio. This reduces an investor’s reliance on a small number of stocks for their capital returns or income. After all, a narrow stock choice in a portfolio could increase the risk of that passive income being dented by poor returns from one or two companies. The end result of diversification could be a stronger, and more resilient, passive income in the long run.
Holding cash to reduce risk
As mentioned, cash savings offer a disappointing passive income due to low interest rates. However, holding some cash can be a sound move.
For investors who seek an income today, cash can act as a buffer should the economic outlook deteriorate. This was the case in the first part of 2020, when many companies postponed or cancelled their dividends in response to the coronavirus pandemic.
Similarly, holding cash can allow an investor who is building a portfolio to take advantage of sudden declines in share prices. This may enable them to use market cycles to their advantage in building a larger portfolio with a more generous passive income in the long run.
