Building a portfolio of stocks that pay dividends can be a great way for me to generate passive income. But dividend stocks can be risky. When the underlying businesses go through difficult times — as all businesses do — the dividend payments can drop, causing the share price to fall.
I’ve developed a plan for building a passive income portfolio while trying to limit the risk associated with individual stocks. And no amount of money is too small to get started — I could do it with as little as £2 per day.
Macroeconomics
The plan involves concentrating on two macroeconomic factors — inflation and GDP growth. At any given time, one of four things can be happening.
- Both inflation and GDP growth are accelerating
- Both inflation and GDP growth are decelerating.
- Inflation is accelerating, GDP growth is decelerating.
- Inflation decelerating, GDP growth is accelerating.
Different types of company perform well in different macroeconomic situations. Accordingly, the plan is to invest in stocks in different sectors. If this is successful, the result will be a portfolio where there’s always something that’s doing well and always something that is available to buy.
The plan is inspired by Ray Dalio’s all-weather approach to investing. But where Dalio invests across various asset classes, including bonds and commodities, I’m going to concentrate on stocks.
Environment 1
When inflation and GDP growth are both accelerating, consumer discretionary companies and energy companies tend to do well. Accelerating GDP growth provides a benefit for consumer discretionary companies and energy companies benefit from rising commodity prices. To prepare for this type of environment, I’d look at having shares in companies like Howden Joinery and Enterprise Products Partners in my portfolio.
Environment 2
Healthcare companies and consumer staples companies fare well in an environment where inflation and GDP growth are both decelerating. Healthcare companies are immune to the effects of decelerating GDP growth. Consumer staples companies benefit from lower costs of raw materials when inflation is decelerating. Two companies that I have in my portfolio to prepare for this situation are Bristol-Myers Squibb and Reckitt.
Environment 3
To prepare for a situation where inflation and GDP growth is slowing down (sometimes called stagflation), I’d look to own shares in REITs and utilities. Both of these companies own substantial tangible assets and this gives them protection from inflation and the effects of decelerating GDP growth. Companies that I think are attractive here include NextEra Energy and Realty Income.
Environment 4
Lastly, inflation could slow down while GDP growth increases. In this situation, I’d like to own technology companies and basic materials companies. Both should benefit from the acceleration in GDP growth without having to be concerned with inflation. Two companies that I think are attractive here are Microsoft and Rio Tinto.
Summary
Nothing is guaranteed in investing and no portfolio is completely immune from stock market vicissitudes. buying and holding shares in a diverse range of sectors, I am to develop a portfolio that will produce passive income consistently in any macroeconomic environment.
What could £2 a day achieve? The above portfolio has a dividend yield of 4.71%. Depositing £2 a day and compounding at 4.71% (which isn’t guaranteed) should generate £51 in year one. That’s not much. But if I can keep adding, compound interest takes the return to £464 in year 10, £1,181 in year 20, and £2,329 in year 30. And that’s just with £2 a day.
