Holding dividend shares for the long term can yield a chunky passive income. By owning a collection of stable, prominent enterprises, I can sit back and watch the money roll in without having to lift a finger. And if I decide to reinvest any dividends received, my secondary income stream can become quite impressive after several years.
Kick-starting any passive income journey in the stock market can be a daunting task. But if I were starting from scratch today with £10,000, I could immediately achieve a £600 passive income overnight. And this may eventually grow into something far more substantial. Here’s how.
Achieving a 6% yield
Looking at the FTSE 100, the average payout an investor can expect is around 4%. And by investing using an index fund, there isn’t much wiggle room to improve that. But for stock pickers, individually selecting top-notch, dividend-paying companies can quickly push this yield higher.
Chunkier payouts can sometimes be a warning sign. However, with the recent stock market correction sending valuations into the gutter, hitting a 6% yield in 2023 is far easier than before. And it doesn’t necessarily involve taking on much extra risk either.
Today, there are 18 companies in the UK’s flagship index offering a 6% yield, or higher. And this number jumps up to 78 when including the offerings from the FTSE 250.
Obviously, not all of these income stocks will live up to expectations. And some already look like they’re on the verge of cutting payouts in light of the ongoing economic challenges. But a few look promising, in my eyes. And by having a mix of high- and low-yield shares in my portfolio, the risks can be spread while the payments remain reliable.
So how do investors identify the winners and dodge the losers?
Avoiding yield traps
As a general rule of thumb, if something looks too good to be true, then it probably is. So as tempting as a double-digit yield might look, chances are it’s a glaring sign to steer clear. Don’t forget dividends aren’t guaranteed. And companies can cut them at their own discretion with little notice.
However, there are always exceptions. So what determines whether a dividend is actually sustainable? The answer effectively boils down to free cash flow.
Companies that can consistently generate increasing amounts of excess cash from operations to the point where the management team doesn’t know what to do with it are often the most likely to evolve into dividend aristocrats.
On the other hand, if a business is taking on debt just to satisfy shareholders, then trouble is likely brewing. While the short-term may look rosy, compromising a balance sheet is never a good sign for longevity.
Keep an eye on things
Just because an income portfolio is terrific today doesn’t mean it will stay that way. Companies are in a constant state of flux. While all strive to become bigger and better, few actually succeed. And even industry titans can eventually lose their thrones to disruptive rivals.
Therefore, it’s important to keep tabs on how each business is operating. That way, investors can potentially catch on early to any looming threats and make informed investment decisions.
