In order to generate a sizeable amount of money from the stock market, some assume that a complicated strategy is needed. In reality, sticking to a simple idea can do just as well. In my opinion, the hunt for passive income that I can enjoy later in life warrants time spent finding a good strategy. Here’s how I’m going about it, without the faff or jargon.
Picking a few good stocks
I completely understand the argument of investing in a lot of different stocks in order to diversify myself. Yet research has shown that beyond a certain point, the benefit of adding more and more stocks reduces. For example, am I that much better off with 1,000 stocks versus 999? I don’t think so.
Therefore, I’d aim to own a dozen stocks for this area of my income portfolio. From this, I can have a broad exposure to different sectors, different-sized companies and also different risk levels. I can take a decision to own a high-dividend-yield share with a 10%+ offering, by offsetting some of the risk with a 4% dividend stalwart.
Granted, there’s the inevitable risk that further down the line one company might stop paying a dividend. But again, with a dozen stocks this impact will be limited. I can adjust and find a new stock, accordingly.
Building a five-figure passive income
I want to aim to earn £50k in total passive income from my portfolio. In order to speed up the process, I’m going to reinvest any dividends I receive to begin with. This helps me to benefit from compounding.
For example, I could have £1,000 invested in a stock yielding 8%. I can use the annual £80 I receive to buy more of the stock. The following year (assuming no changes), my £1,080 will earn me £86.40. By repeating this over several years, my portfolio builds quickly.
If I invest £500 a month in dividend stocks with an average dividend yield of 6%, I’ll have made over £50k in passive income by year 15. At this point, I can look to sell some of my portfolio to enjoy the funds. Or I can leave it invested but spend the future annual income proceeds (£8,800) as it comes through.
Of course, I have to accept that such an outcome isn’t guaranteed, unlike a savings account that offers a fixed interest rate. I know that the value of my investments could fall as well as rise, but I believe the potential reward is worth the risk.
The current average FTSE 100 dividend yield is 3.7%. This is lower than the average yield I’ve assumed for my portfolio. Instead of owning every stock in the index, I’m only aiming to pick a dozen. This allows me to be active and select above-average companies. For example, I’d include the likes of Legal & General and British American Tobacco. Both shares currently have a yield in excess of 6%.
The bottom line is that with regular investment into a small group of sustainable dividend ideas, I can meet my goal over time.
