Last month, inflation hit 10.1%. Yesterday, the latest figures were predicted to be 9.9%, yet it jumped unexpectedly to 10.4%. This isn’t good news for me or anyone in the UK, as inflation erodes the value of the money in my cash account.
One way I’m counteracting this negative pressure is by investing in dividend stocks to make passive income. Here’s what I’m talking about.
Understanding how to account for inflation
At a basic level, let’s say I bought a stock today at 100p. Each quarter, it pays out a 1p dividend. Over the space of the next year, I’ll earn 4p, which corresponds to a dividend yield of 4%. If inflation over the next year averages 4%, I’ll have effectively negated the impact of inflation. I’ll still have my initial capital invested, but the 4% income helps to offset inflation.
I get that this concept is more complicated in real life. For example, my cash doesn’t actually fall in value tangibly. It’s more a case that my money buys me less because prices of items have increased. So it’s difficult to accurately visibly see inflation.
The other point I have to be careful about is trying to beat inflation over time. I’m expecting to make passive income for years and years. So just because inflation is at 10.4% today, does that have to be my target level for the next few years? What if it falls to 5% by the end of the year?
Therefore, I need to pick a reasonable average level that I want to try and reach.
Implementing the idea
My starting point is to figure out what kind of average dividend yield I want. I’m not going to be chasing a 10.4% yield. I can’t build a diversified portfolio of stocks with this kind of number. I also don’t think inflation is going to stay this high for long. Therefore, I want to target a return between 6% and 7% over the next couple of years. From my calculations, this should be enough to offset inflation over this period.
Thankfully, there are plenty of stocks that fit the bill for this yield range. Even just within the FTSE 100, there are 14 shares currently with a minimum yield of 6%.
Ideally, I’d like to pick up to a dozen shares from the FTSE 100 and FTSE 250. Given I want sustainable income, I prefer to stick to larger-cap stocks in this case.
I’m not too fussed about the amount of money I invest. I’m not going to put in all of my free cash, as this could cause me problems in the future if I have an emergency cash need. Rather, I’d prefer to invest what I can afford now, and then look to top up this amount on a monthly or quarterly basis with extra money.
Putting this all together, I feel that I can make my money work harder for me in what could be a tough year ahead.
