I think now is a brilliant time to buy dividend stocks. After a difficult year, many companies on the FTSE 100 look cheap and pay generous yields.
The big attraction of FTSE Dividend Aristocrats is that they pay passive income without me having to work for it. Apart from the effort involved in choosing the right stocks to buy in the first place.
I’m hunting for dividend stocks
This means that top UK companies like Aviva, Diageo, Shell and Unilever are rolling up their sleeves and going to work on my behalf.
Buying dividend stocks isn’t without risk. As we have just seen with housebuilder Persimmon, dividends can be slashed at any time. I would therefore never buy just one stock, but at least a dozen or more, to spread my risk.
If I could generate passive income of £500 a month from FTSE dividend stocks, that would make my retirement a lot easier. Obviously, I would like more if possible.
So how big a portfolio do I need to generate £500 a month – or £6,000 a year?
Right now, the FTSE 100 as a whole yields 3.8%. However, a number of stocks offer higher income than that. For example, insurer Anglo American yields 6.71% a year, while Vodafone yields 8%.
Let us say I build a portfolio with an average yield of 5%. To generate £6,000 a year I would need a portfolio worth £120,000.
The next step is to work out how much I would need to put away each month to build such a pile. I am going to assume I am starting from scratch and investing £250 a month, or £3,000 a year. I also assume that I increase my contribution by 3% a year to keep up with inflation, and my portfolio enjoys an average total return of 7% a year. Not that this figure is guaranteed, of course.
Through the power of compounding, it will take 17 years to hit my target and I should have £120,854.
The longer I invest, the more my money should compound and grow. Over a 25-year term, I would have a far more impressive £267,526. With a yield of 5%, I would generate £13,376 a year, or £1,115 a month. This shows the benefits of starting early and investing for the long term.
We live in uncertain times and this may deter some from buying dividend stocks. For me, it’s the reverse. I think this year’s turbulence makes now a good time to buy FTSE 100 shares, as many are trading at cheap valuations.
FTSE 100 stocks look cheap
Rio Tinto, which currently yields 10.65%, now trades at 4.93 times earnings. Given that 15 times earnings is seen as fair value, it looks like a bargain.
There are risks, of course. Such high yields are rarely sustainable. Persimmon recently yielded 20% and that was definitely unaffordable. Rio Tinto’s looks more solid, but as I said, there are no guarantees.
Over the longer term, I think both stocks can deliver a steady flow of dividends, and help me hit my passive income target. That’s why I bought them.
Now I’m looking for others, with Tesco and Unilever on my shopping list. With luck when I reach retirement, my dividend stocks will carry on working while I sit back and relax.