Investing regularly in dividend stocks can be a great way to earn passive income. By harnessing the power of compound returns, it’s possible to build a stock market portfolio that could eventually yield £2,000 in dividends each month.
Here’s how I’d aim for £24,000 in passive income a year with a spare £200 to invest every month.
Achievable targets
I think it’s important to be realistic when setting goals for my portfolio returns. Conservative targets are easier to achieve and less likely to disappoint. So, my first step in my quest for a second income is to look at the FTSE 100 index.
The UK’s blue-chip benchmark is a good yardstick to measure my ambitions against. According to IG, the FTSE 100’s total return per year since its inception to 2019 was 7.75%. This calculation assumes all dividends are reinvested and that’s exactly how I’d aim for a big passive income stream in my older years.
I hope I could beat the index with some careful stock picks. But this does carry risks. My investments would be less diversified. As a result, they could underperform the broader market. This would delay my progress in reaching my goal, or even send it into reverse. On the flip side, if my shares outperformed the Footsie, I’d reach my target sooner.
Accordingly, I’m going to use the average index growth rate to model my assumptions. That way, if my hand-picked equities perform better, I’ll be pleasantly surprised.
Investing in dividend shares
So, how big would my portfolio need to be?
I’m targeting a 4% dividend yield. This is a little above the average yield for FTSE 100 shares at 3.6%. However, as my shareholdings will be concentrated in dividend stocks, I think it’s reasonable to aim for a higher yield.
Some notable high-yielding shares include Rio Tinto (8.65%) and British American Tobacco (7.07%). However, it’s important to note dividends aren’t guaranteed. Shareholder payouts can be cut or suspended at any time.
Therefore, I’d also invest in some lower-yielding stocks that have an excellent track record of delivering consistent distributions, even in tough economic climates. Dividend Aristocrats that I’d consider are Diageo (2.19%) and Unilever (3.49%) — although their dividends aren’t guaranteed either.
With a variety of stocks on my watchlist to spread my risk exposure, the next step is calculating my exact target. In order to secure £2,000 in passive income per month at a total 4% annual yield, I’d need a total portfolio value of £600,000.
Compound returns
Setting aside £200 per month to invest and assuming my portfolio grows in line with the FTSE 100’s historic average, I could hit my £600k target in just under 39 years.
That might sound like a long time. Nonetheless, if my investments outperform or I was able to set aside a little extra in the odd month here and there, the compounding effect would snowball faster.
In any event, I’m a long-term investor. As Warren Buffett said: “The stock market is a device for transferring money from the impatient to the patient.” That chimes with my philosophy of building wealth slowly over a long time horizon in order to secure a second income in later life.
