Owning dividend stocks is a great way to earn passive income. These stocks provide me with regular, albeit not guaranteed, payments and require minimal effort from myself. Although as with any investment, there are risks. So choosing the right dividend stocks for my portfolio can be the tricky part.
Today, I’m looking at how I could generate £500 a month in income by investing in dividend stocks. So let’s take a close look at how this is possible.
Generating £500 passive income a month
£500 a month works out at £6,000 a year. So if I had £120,000, I could simply invest in stocks paying a 5% dividend yield. And right now, with share prices being pushed down, there are quite a few yields above 5%.
But what if I don’t have £120,000 right now? Well, if I only had £20,000, I could turn this figure into £120,000 in just 10 years using the following steps. Firstly, I’d invest this £20,000 in dividend stocks offering 5% yields and then I would reinvest my dividend payments every year. This is a process called compound interest.
And on top of that, if I invested just £600 every month for 10 years, at the end of the period I’d have £126,000.
The longer I practice compounding interest, the more I’d have in the end. After 30 years, I’d have nearly £600,000. That’s the miracle of compounding interest. But, importantly, £120,000 is enough to generate £500 a month in passive income.
Stock-picking
While the theory sounds easy, picking the right stocks can be the hard part. My top dividend stocks right now operate in several sectors.
Stocks in banking and certain areas of finance currently look pretty good. Interest rates are on the rise and this has been pushing their margins right up. Prime minister Liz Truss is also planning to drop corporation tax hikes and this would effectively mean a five percentage point cut in banks’ tax bills.
Lloyds is among my favourites. The lender, which is focused heavily on the UK mortgage market, currently offers a 5% dividend yield. Banks are also pretty steady when it comes to dividend payments. If I were investing for 10 years, I’d be relatively confident that the dividend wouldn’t be cut completely, unless there was another global challenge like Covid-19.
While housing stocks aren’t in vogue right now, I’m pretty bullish on the sector in the long run. And housebuilders are currently offering sizeable dividend yields. In fact, Persimmon currently has a 16.5% yield. That’s huge and probably unsustainable, even though the dividend forecast for 2023 is largely the same as 2022.
I’d be happy to buy Persimmon for an 8% yield if the firm was forced to cut the dividend in light of an increasing difficult near-term environment.
