Passive income is the dream that got me interested in investing. Who doesn’t want to make money while they sleep? Unfortunately, it’s not as simple as it sounds, but it’s not impossible either. I just need to own something that generates value. This could be a business or a rental property. I don’t have the capital to buy one of those right now. Instead I’m focusing on dividend investing, and aim to build a portfolio with just £25 per week.
Dividends are a portion of a company’s profits paid to shareholders throughout the course of a year. Some companies only do this once but many will issue them two, three, or even four times a year. It’s important to note that dividends are never guaranteed – they can be stopped, suspended, or reduced by a company’s board.
What I really like about focusing on dividends is that I can take those payments and re-invest them, increasing size of my portfolio over time and growing its potential yield exponentially.
A dividend yield is the amount paid to shareholders, per share, and is based on the stock price at that given time. So, if a share is worth £100 and the company issues a £1 dividend per share, then the yield is 1%.
The average yield in the UK at time of writing is between 3.5% and 4%. Some companies can pay as high as 10% or even 13%. That’s better than the average stock market return. However, dividend yields are at unprecedented highs right now and the problem with such large yields is that they are often unsustainable. If a company keeps paying its shareholders millions of pounds out of its profits each year, it has less capital to invest in itself.
Balancing the portfolio
I would be lying if I said I wasn’t tempted by some of these higher yields. But if I intend to hold shares for a long time, then I need to be confident that the shares won’t fall drastically in value, and that a dividend will be paid consistently.
Unilever is a good example of the former. This consumer goods conglomerate’s share price has been on a downtrend since reaching its all-time high in 2019 (5,196 p). But, over the course of the share’s lifetime it has usually trended upwards, increasing 51% between 2009 and 2014, then 63% between 2014 and 2019.
Imperial Brands is an excellent example of the latter. The tobacco company has issued a payment at least twice a year since 2002. Its shares have fallen quite a lot since 2016, but the company has shown excellent consistency.
Unilever and Imperial Brands currently offer 3.37% and 8.7% yields, respectively, and I think these two companies balance out my risk. Imperial Brands’ dividend is a little high for me to really see as sustainable. But my expectations are set at 4% I won’t be disappointed if that yield drops.
Passive income expectations
£25 per week doesn’t feel like a lot but it adds up to £1,300 per year. Saving that much over 30 years eventually reaches £39,000. The best part though is that, through dividend investing, I can reasonably expect to add 4% on top of that each year, maybe even more. It won’t make me rich on its own, but it could become a very reasonable supplement to my pension.
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James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands. 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.