Investing in the stock market is one of many methods to build a passive income. And while there are alternative strategies, such as buy-to-let or starting a business, income investing is a far less hands-on approach.
There’s still a lot of initial effort required attempting to identify sustainable and reliable dividend stocks. But once capital is put to work, there’s not much to do but sit back and wait for the money to roll in. And, best of all, generating £100 a week doesn’t require much up-front capital.
With that said, let’s explore how to do it.
Slow and steady
As wonderful as it would be, dividends aren’t paid on a weekly basis. A business’s distribution of excess capital to shareholders is entirely up to the management team. And it can decide how much, and how frequently, to pay (usually it’s once every quarter).
That’s why it’s far more realistic to aim for £5,200 a year – the equivalent of £100 a week.
Looking at the UK’s flagship index – the FTSE 100 – investors can enjoy an average dividend yield of 4%. But this quickly highlights a problem. At this level of return, a portfolio would have to be worth around £130,000 to deliver £5,200 in annual passive income. That’s not exactly pocket change.
Hand-crafting a custom dividend portfolio could realistically raise the yield to around 5% without taking on too much additional risk. However, that still means £104,000 is needed. So how can investors overcome this financial barrier?
The answer is actually quite simple – invest in the stock market. Instead of trying to unlock impressive payouts right away, investors can slowly drip-feed excess money from their monthly salaries into an investment portfolio, reinvesting any dividends received.
Suppose an individual can match the 8% total annual return of the FTSE 100 and can spare £500 each month for investing. In that case, it will take roughly 10 years to build the required six-figure portfolio and unlock the target passive income stream.
Investing isn’t risk-free
The stock market can be a volatile place, as 2022 has perfectly demonstrated. And even the best businesses in the world can be derailed by external forces.
This can be particularly problematic for income investors, since dividend payments are ultimately optional. And when companies are seeking to retain capital to weather any financial turmoil, dividends are usually the first up on the chopping block.
In fact, looking at the latest UK Dividend Monitor report by Link Group shows that total shareholder payouts collapsed by 44% in 2020. Admittedly that was an exceptional year. But it goes to show that dividends don’t always go up. And the same can be said about stock prices.
Stock market crashes and corrections are an unavoidable reality on an investing journey. It’s entirely possible another will occur within the next decade, potentially sending share prices plummeting. Depending on the timing of these events, it may take longer than expected for an investor to hit their passive income target.
Nevertheless, the long-term rewards of building an investment portfolio outweigh the risks, in my opinion. And given the process takes some time, starting right now could be a wise move.
