It’s no secret that inflation has wreaked havoc on markets in the past 18 months. And with that, it’s no surprise that many investors are focusing on generating passive income.
Investing in companies with high dividend yields is a great way to put money to work as opposed to it stagnanting.
However, it’s smart to have a strategy before targeting passive income. And there are plenty of considerations that must be taken into account to ensure a greater potential for success.
Let’s explore these further.
The strategy
The first consideration is my timeframe for investing. Often we see the promotion of investing is to ‘get rich quick’. But as a Fool, I much prefer to view my investments over a long-term horizon.
As billionaire investor Warren Buffett famously said: “If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes”. And more often than not, the stock market has proven that investing with a long-term outlook is the best way to extract the benefits.
Granted, investors may find it difficult to remain persistent when they see the value of their investments falling. But by viewing them over a timeframe of five to 10 years minimum, short-term volatility is ironed out.
Secondly, I must also consider methods I can use to boost my profits. This predominantly exists in the form of reinvesting my dividends. By doing this, I can benefit from compounding which, over time, will allow my pot to continue to grow at a greater pace.
On top of this, I can also generate greater returns by consistently adding to the size of my investment.
£500 invested in a stock generating 7% growth a year (which, of course, I may not achieve) with a 6% yield would leave me sat with £24,000 after 30 years. However, if I topped this up with a monthly payment of £30, over the same period, my pot could be worth over £150,000.
Finally, I’d diversify my investments. By doing this, I’d reduce my reliance on one company or industry.
Putting this into practice
So if that’s the strategy, how do I implement it? Well, I think the FTSE 100 is a great place to start.
The index is home to a variety of quality companies with growth potential that also offer high dividend yields.
There are over 15 companies that offer yields of 6% or more, spread across industries such as investments, tobacco, housebuilding and insurance. This includes firms such as Rio Tinto (8%), British American Tobacco (9%) and Legal & General (8.5%). And its quality companies with long-term growth potential that I’d target.
More widely, I’d also look at companies that offer yields above the index’s average of 4%. Here, I like the look of HSBC and Lloyds.
Of course, there are risks. Firstly, I wouldn’t buy a stock solely due to its dividend yield. And greater research would have to be done to convince me it has the long-term growth potential I’m seeking.
Additionally, the risk with targeting dividend stocks is that payments can be reduced, or cut altogether, as seen on multiple occasions. I must be aware of this.
However, by employing this strategy to the correct companies, I’m confident I could build wealth.
