I’m aiming to build a portfolio capable of delivering £500 a month in passive dividend income from dividend stocks.
And I reckon a realistic outcome, in the end, is for my investment pot to deliver an overall dividend yield of around 4%. That implies my share fund needs to be worth about £150,000 before I can take £500 a month in passive income from my dividend payments.
Regular investing on an average salary
One way of achieving it is to start off with £150k and invest it in solid, dividend-paying stocks. Or perhaps bung it all in a FTSE 100 index tracker fund, which has a good chance of delivering a yield averaging around 4% over time. But that’s not the start of my plan. Though it is the end of the plan.
There’s a slight problem to overcome in the years between the beginning and the end of the plan — I don’t want to invest £150k all in one go. In fact, the idea is to build up the portfolio to its full value over a number of years. And to do it while earning nothing more than an average salary.
Key to unlocking the potential of this strategy is to harness the mighty power of the process of compounding. And that’s because gains reinvested and built on earlier gains can snowball into large amounts over time. That’s why the legendary investor Warren Buffett’s official biography is called The Snowball. And he snowballed a few dollars into many billions over his investing lifetime.
My ambitions are more modest. And, of course, even then there’s no guarantee I’ll succeed. But to begin the process of trying, I’ll invest money each month and send it to a tax-efficient investment ‘wrapper’, such as a Stocks and Shares ISA, or a Self-Invested Pension Plan, or both.
Compounding income from dividend stocks
The next decision is to nail down an investment strategy. For example, I could try to identify small, fast-growing businesses and hold their stocks as the underlying growth story unfolds. Or I could trade mature stalwart companies based on valuation for shorter-term gains. Those two methods were used to great effect by outperforming fund manager Peter Lynch when he ran Fidelity’s Magellan fund in the US.
And there’s nothing wrong with those strategies. However, this strategy aims to build up value by reinvesting dividend income from solid businesses. Sometimes, a slow and steady approach can be effective. And it relies on cash in the hand rather than on future share-price movements. But all shares carry risks. And despite a measured approach to investing, I could still potentially lose money or suffer disappointing returns.
But choosing dividend-paying shares carefully could help me to succeed. So, I’m looking for defensive businesses with a long record of cash-backed dividends. However, I wouldn’t buy any shares without first undertaking my own research. And there’s no guarantee stocks will perform well for me just because I like them now.
Nevertheless, high on my list of stock candidates for this strategy are smoking products maker British American Tobacco, energy company National Grid, and food ingredients manufacturer Tate & Lyle.
And I'm also looking here:
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco and 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.