Dividend shares can be a great source of passive income. And a focus on dividend yields can be a good starting point to help anchor an investment to a reasonable valuation.
On top of that, dividends can be good way of securing returns from a stock investment. The alternative is to rely on the invested capital getting bigger because of rising share prices. But market movements can be unpredictable.
Dividends can reflect business performance
However, harvesting shareholder dividends is a way investors can benefit from the performance of a business. And that’s regardless of what the share price might be doing.
The cash flowing into a business provides the means for companies to pay dividends. And that means investors can often align themselves with the fortunes of an enterprise by collecting its dividends.
And I’d aim to set up my strategy to benefit from regular streams of dividends. For an example, I’d set up regular monthly payments of £300 into my share account. And a Stocks and Shares ISA would be my preferred type of account because of the tax advantages.
Many share account providers offer a low-cost regular investment service into popular dividend-paying shares. And I’d use that as well as taking advantage of their low-cost dividend reinvestment services.
Using the power of compounding
You see, a key part of my plan to target £2,000 monthly income from dividend shares would be to reinvest all dividend income along the way. And I’d do that with the aim of compounding the value of my investments over time.
I’d be in the building stage of my portfolio. And the idea would be to aim for it to grow so that it could produce the desired monthly income from dividends later.
But it wouldn’t be a get-rich-quick scheme. Many sources cite the long-term compounded annual total return of the stock market as being a high single-digit percentage. And I estimate my portfolio would need to be worth about £600,000 to produce a dividend income of £2,000 a month. That’s assuming it can produce an overall dividend yield of about 4% in the end.
A long-term strategy
And it would take around 37 years to get to £600k if my compounded annual gain from total returns came in at 7%. But such outcomes are never guaranteed. And there would likely be differences from year to year. Indeed, some periods could even produce a negative return.
However, I’m optimistic the plan could work out well over the long term. So I’d aim to spread my monthly investments over several dividend-paying stocks. And I’d hunt for businesses with steady financial characteristics. But they’d need to have the potential to grow their revenue, earnings, cash flow and dividends over time.
For example, stocks such as Imperial Brands, GSK, National Grid, SSE and IG Group would all be worth my consideration. And I’d likely allocate some of my money to a FTSE 100 index tracker fund as well.
