Creating lifelong passive income with just £4 a day! Here’s how

Passive income via dividend stocks is an important part of my portfolio. Here’s how I could make £12,500 a year in passive income from just £4 a day.

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My investment strategy largely revolves around utilising dividend stocks to generate long-term passive income. The thing is, I don’t tend to need the dividend payments I receive right now. So I reinvest my profits to benefit from compound returns.

My strategy

This is the process of reinvesting my returns and earning interest on my interest. The longer I leave it, the more I will have in the long run. For example, if I started with £10,000 and invested in stocks with a 5% yield and reinvested my dividends, after 40 years I’d have £73,000. That’s a huge return.

But if I were to contribute just £4 a day on top of my initial capital, after 40 years I’d have £256,000. And that’s enough to generate around £12,500 in passive income for me each year, if I had it in dividend stocks paying 5%.

Naturally, this equation doesn’t take into account any share price growth. And, of course, dividends are not guaranteed. I could even lose money on my investments. But this is how my strategy can work. Some £12,500 a year in passive income may even support me in my retirement.

Where to put my money?

The most important thing with regards to the strategy is picking the right stocks. I’m looking for firms that will still be operating in the decades to come. But I’m also looking for companies that offer sizeable, yet sustainable, dividends.

Some of my top picks are banks and financial institutions. Many of these have been around for decades, and even longer. They are part of the fabric of the UK economy and operate in fairly stable industries.

HSBC could be a good pick. It’s been on a bull run this year, so the dividend yield is only 3.5%. But it was closer to 5% when I bought.

HSBC has its core business in the steady European markets, but it has considerable exposure to high-growth markets in Asia. It could be a good long-term pick as a result. HSBC is also a £100bn company with all the required checks and balances in place. I don’t see it failing any time soon.

Albeit more cyclical than the above, I’m also interest in housebuilders. Right now, the dividend yields in the sector are pretty sizeable, and I’ve bought shares in several developers this year. But being a cyclical industry, these stocks can appear to trade at a discount.

Given the UK’s acute shortage of housing, I’m backing housebuilders to outperform other stocks in the long run. As a result, I’d buy firms like Persimmon. The developer giant is trading 40% below this time last year.

Other options include pharma giant GSK, which is down considerably at this moment amid legal challenges in the US. Meanwhile, I’d also be interested in consumer good business Unilever, which owns many household brands. These types of brands tend to do well, regardless of the economic situation.

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 GSK, HSBC, Persimmon and Unilever. The Motley Fool UK has recommended GSK plc, HSBC Holdings, and Unilever. 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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