Owning assets such as dividend stocks is one of the best ways of earning a second income, mostly because it doesn’t take much effort. In the stock market, investors like me can buy shares in companies and collect cash dividends without having to do anything more.
Furthermore, shareholders can reinvest their dividends in order to earn even more in the future. And there are give good reasons to think it’s better to start now than to wait for a better opportunity.
Interest rates are high
Interest rates are currently at 5.25%, meaning that cash and bonds are offering decent returns. That might make it look like a bad time to start buying dividend stocks, but that’s not quite true.
Higher rates have caused the price of dividend shares to fall. As a result, stocks that previously had fairly unremarkable dividend yields have moved into much more rewarding territory.
One example is Warehouse REIT. The share price is down by around 23% this year and the dividend has increased from 6% to just under 8% as a result, making it a much better time to buy shares in the company.
There are still plenty of risks for investors to consider, such as a slowing property market weighing on the value of the company’s assets. But those risks are worth taking with a higher dividend on offer.
Yield curve
Furthermore, it seems likely that high dividend yields aren’t going to be around forever. At the moment, there’s an inverted yield curve (with 2-year bonds currently yielding 5.12% and 10-year bonds yielding 4.5%).
This reflects an expectation that rates will peak in 2024, before falling back below 4% in the next five years. If that – or anything like it – is accurate, then dividend stocks look like a much better option than cash or bonds.
In other words, there’s reason to think the opportunities in dividend stocks available right now aren’t going to last. But investors who buy shares at today’s prices can keep receiving dividends for as long as the company keeps paying them.
The prospect of falling interest rates is one reason for buying dividend stocks today, rather than waiting for a better opportunity. But there’s another reason that’s arguably even more powerful.
Compound interest
Earning a second income by reinvesting dividends can have some spectacular results. But building an investment portfolio that can generate significant returns takes time and the cost of waiting to get started can be high.
Suppose that I manage to achieve an average annual return of 6% through my investing career, while investing £100 per month. If I start today, I’ll have a portfolio paying me just over £5,500 per year in passive income after 30 years.
By contrast, if get started in 2028, earning 6% per year will only take me to £3,800 per year in 2053. By starting now, rather than waiting five years, I can add an extra 45% to my annual income 30 years down the line.
This is because compound interest means that investors earn a return on the dividends they reinvest as well as their initial capital. This adds up over time and is possibly the biggest reason why today is a great time to buy stocks.
