We’d all love a second income. Just a little something to make life easier. This is the holy grail for many investors. So here are my three steps to generating £1,000 a month by investing in stocks.
1. Realising what it takes
To generate £12,000 a year, or £1,000 a month, I’d need a lot of money invested in dividend stocks. That could be £200,000 invested in stocks yielding 6%, or £150,000 invested in stocks paying an 8% yield.
Obviously, we all have different starting points. If I had £200,000, I could simply invest today in stocks with big yields, sit back, and enjoy the dividends.
But the reality is that most of us are starting with very little. In fact, in my age group the average ISA size is less than £10,000. This makes earning £1,000 a month more challenging, but not impossible.
Using a compound returns strategy, targeting 10% total returns, and just £10 a day, I could go from nothing to £200,000 in just 18 years.
Another important factor is the forward yield. If I had £100,000 to invest, I would choose stocks where I’d expect to see the yield rise in the coming years, while reinvesting my dividends to grow the pot.
For example, Lloyds currently offers a 5.8% yield. But extrapolating analysts’ forecast for the next couple of years, it’s entirely possible the forward yield for 2028 is around 9%.
It’s entirely feasible that £100,000 invested well today could well be generating £1,000 a month in five years’ time. That’s because of portfolio growth, but also the fact that the yield I receive is always based on the price I paid for the stock.
2. Targeting sustainability
When investing for dividends, sustainability is hugely important. The last thing we want to do is invest in stocks paying large dividends, only to discover the company can’t afford to pay them.
When assessing the sustainability of the dividend, the first place to look is the dividend coverage ratio (DCR). This tells us how many times a company can pay its dividends from its earnings over a year.
Typically, a DCR of two and above is considered healthy. Lloyds’s dividend is covered three times, making it particularly strong.
We can also look at cash flows and profit guidance for the coming year. Collectively, these should tell us whether the company will have the funds available to pay shareholders.
3. Taking the opportunity
It’s important to remember that share prices and dividends are inversely correlated. In other words, when share prices fall, dividend yields go up. That’s why it can pay to buy in a dip, not just because the share price has greater perceived upside.
Obviously, shares can dip for a reason. So we need to be wary.
But in a more general sense, it can pay to buy stocks in depressed markets and take advantage of big yields. The current market presents these opportunities, in my opinion, especially when we look at financial stocks.
I’ve been topping up on stocks like Lloyds and Legal & General (8.5% yield) as the share prices have pushed downwards. As billionaire investor Warren Buffett says, net buyers of stocks benefit when share prices go down.
