There are many ways to go about building a passive income stream. Yet most commonly shared ideas like starting a business, buying rental real estate, or drop-shipping actually require constant effort.
But when it comes to dividend stocks, it’s by far the most hands-free, income-generating approach I’ve encountered. And best of all, anyone can get started with as little as just £3 a day. Here’s how.
Saving little and often
Preparing a packed lunch instead of hopping to Tesco for a £3 meal deal each day can add up over long periods. It works out to £21 a week, which translates into £1,095 per year. And that’s more than enough to start putting together a passive income portfolio.
The FTSE 100 currently offers a dividend yield close to 3.8%. However, by being more selective and focusing exclusively on income stocks with a track record for growing shareholder payouts, it’s not unreasonable to achieve a portfolio yield closer to 6%, without taking on too much additional risk.
In the first year, the portfolio isn’t going to generate anything exhilarating. After all, 6% of £1,095 is just £65.70.
But this income stream can start rapidly growing, given time, thanks to compounding. And if I re-invest all dividends along the way, after 40 years – the average time spent working – my portfolio would reach roughly £181,724, generating around £10,900 per year.
But this doesn’t include any potential gains from share price appreciation. If the portfolio’s total return were to match the stock market’s average 10% return each year, my wealth would stand closer to £577,000, or £34,620 annual passive income. That’s certainly a nice retirement fund for just £3 a day, in my opinion.
Passive income from dividends isn’t risk-free
Like any investment, dividend stocks still carry risk. They’re least known for wild share price fluctuations seen in growth stocks. But the underlying businesses can still have their cash flows disrupted. And when the money stops flowing to the bottom line, dividends often become compromised, resulting in cuts, or suspensions to shareholder payouts.
This risk can’t be avoided entirely since sometimes companies are disrupted through no fault of their own. Just take a look at what happened with travel stocks during the Covid-19 pandemic.
However, risk exposure can be minimised through careful research and diversification. By analysing business models, investors can find where the internal weaknesses lie. And by ensuring a passive income portfolio contains a variety of top-notch enterprises from multiple industries, the impact of one becoming disrupted can be offset by the others.
The bottom line
It’s impossible to know for certain what will happen in the future. And even after investing time and effort into building a strong dividend portfolio, it may fail to live up to performance expectations, especially if a poorly-timed stock market crash or correction comes along.
Nevertheless, income investing can still be a lucrative endeavour and help families with even the smallest amount of savings secure a more comfortable lifestyle in the long run.
