Investing in dividend stocks is a great way to earn passive income with minimal effort. There are plenty of dividend shares in the FTSE 100 index, which counts a number of cash-generative companies among its constituents.
What’s more, it doesn’t take a fortune to start earning a second income from the stock market. Here’s how I’d aim to build a passive income portfolio by saving and investing just a fiver a day.
1. Start saving
To invest in dividend shares, I’ll need spare cash that I don’t mind setting aside for the long term. Stocks are notoriously volatile assets in the short term. However, the share prices of high-quality companies have tended to trend upwards historically.
Inflation is currently at sky-high levels — the Consumer Prices Index (CPI) rose by 10.5% in the 12 months to December 2022. This means my cash in the bank is losing value in real terms every day.
Although past performance doesn’t guarantee future results, the stock market has traditionally been a good place to put money to keep up with the rising cost of living.
With that in mind, I’d set myself an achievable target of saving £5 a day to buy stocks. That’s a little over £150 a month, or £1,825 a year.
Cutting back on a daily coffee purchase, storing loose change in a piggy bank, and cancelling any unused subscriptions are all ways to make this a reality without living on beans on toast or forgoing a summer holiday.
2. Invest in dividend stocks
Once I’ve built up an investment pot, I can buy some dividend stocks. The FTSE 100 is a good place to start.
There’s always a risk with dividend investing that a company might cut or suspend its shareholder payouts. Indeed, many businesses did exactly this during the 2008 financial crisis and more recently in the 2020 stock market crash when the pandemic struck.
That’s why I believe there are huge merits in diversification. By ensuring my money is spread across different companies in different sectors, I hope I can still benefit from regular passive income streams from my other investments if any one company I’m invested in stopped paying dividends.
I’d begin my search by looking at dividend aristocrats. These are firms that have consistently maintained or increased dividends over long periods. Some examples include British American Tobacco, which yields 7.17%, and industrial engineering business Spirax-Sarco, which yields 1.22%.
Higher yields can be found, like Vodafone‘s 8.38%. I think such companies have a place in my portfolio, but there is a risk the dividends are less sustainable.
3. Set passive income goals
Let’s say I managed to secure a 5% average yield across my portfolio. After one year of following my passive income plan, my holdings would give me £91.25 in annual dividend income.
That might not sound like a huge amount. But, if I continued to save and invest regularly, this figure could quickly snowball.
If I didn’t need the income to supplement my salary, I’d reinvest the dividends into more equities within a Stocks and Shares ISA. This would allow me to benefit from a compounding effect and set me well on my way to building a passive income empire!
