I’m investing before the recovery for passive income potential

Who wouldn’t want to get paid for doing nothing? Passive income is an important part of my strategy to enhance my earnings, and maybe retire early.

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I’m always on the lookout for shares offering passive income in the form of dividend payments. This is especially true as inflation hits levels not seen in decades.

But, with regards to my long-term plan, right now is a good time to invest in my passive income strategy. Valuations are low and dividend yields are high.

So, let’s take a close look at what I’m doing.

My strategy

I prefer dividend stocks to growth stocks as I believe there is less volatility here. But there are two ways I can use my passive income earnings from dividend stocks.

Firstly, if I don’t need the money now, I can benefit from compound returns. This is the process of earning interest on my interest. And the longer I do it, the more I earn.

Let’s pretend I invested £10,000 in company paying a 5% dividend yield, and reinvested my dividends back into the stock every year. Assuming the dividend stayed the same, I could expect my initial £10,000 to be worth £27,000 after 20 years. That’s the power of compounding, and if I build a big enough pot, maybe I could retire early.

But sometimes I might need my dividends. In which case I can simply withdraw that money from my portfolio and use it to supplement my income.

Why now?

I think now is a good time to invest in my passive income strategy because valuations are low and dividend yields are high.

Non-commodity stocks have generally fallen considerably over the last year, but many companies are still registering positive results.

As a result of the falling share prices, dividend yields are actually pretty sizeable right now, especially in sectors such as property, insurance, and banking.

And it’s important to remember that my dividend yield is always relative to the price I paid for that stock, regardless of whether the stock gains in value or not.

That’s why I’m buying now, before the market recovers.

My top passive income picks

It’s worth remember that massive dividends are often unsustainable, so I need to look at companies offering realistic payments and ideally not in cyclical sectors. Although the latter is easier said than done.

I think Legal & General is a sensible pick. The stock is offering a very attractive 7.1% dividend yield. It’s a cash generating business and a household name that will continue to attract customers. It might not be a great few months for asset management, but in the long term, I’m confident Legal & General will prosper.

I also favour stocks in the housing sector. Vistry Group is one that has done particularly well in recent years, going from strength to strength since the worst of the pandemic. Pre-tax profit is expected to come in at the top end of market forecasts (£417m). That’s way above pre-pandemic levels and far above the £319m achieved last year. It’s currently offering a 6.5% dividend yield.

Barclays is down today after a huge charge impacted profitability. But it’s a cheap bank with a household name. I don’t think it’s going anywhere. I’d buy this stock and its 4% dividend yield and hold it for the long run. Higher interest rates should boost margins in the near-medium term too.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox owns shares in Legal & General, Barclays and Vistry Group. The Motley Fool UK has recommended Barclays. 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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