Building a sustainable passive income is one of the best ways to achieve financial freedom. So it’s no surprise that plenty of investors seek to achieve this goal with dividends.
Companies generating excess cash flow often redistribute them to stockholders, including those with only a few shares in their portfolio. And while establishing a sizable income stream in the stock market does require a relatively large portfolio, it doesn’t actually take that much money to get the ball rolling.
Growing my money
2024 is a special year for income investors. With so many companies still trading at discounted valuations caused by the recent corrections, yields are now much higher than usual. So much so that achieving a 6%-yielding portfolio is no longer as crazy or risky as it once was. And at 6%, to generate a second income of £3,000 a year, I’m going to need a portfolio worth roughly £50,000.
Obviously, that’s not pocket change. But by regularly drip-feeding capital into high-quality income stocks and reinvesting any dividends received, reaching this threshold isn’t as impossible as it may seem.
Let’s say that after covering all living expenses, an individual has £300 to spare at the end of each month. By investing this money into a high-yielding portfolio that also delivers another 4% return through capital gains, the total return becomes 10%. That’s slightly ahead of the FTSE 100’s typically 8% gain and serves as a benefit to opting to pick individual stocks instead of using an index fund.
Investing £300 a month at a 10% annual return would result in a £50,000 portfolio in around nine years. At which point, an investor can start withdrawing dividends instead of reinvesting them, to reap their new passive income stream.
Risk and reward
As previously highlighted, stock picking opens the door to market-beating returns. As such, the timeline to reaching the £3,000 income goal has been accelerated by over a year and a half versus an index fund, despite only being a 2% difference.
However, while this approach helps investors boost their returns, the opposite can also happen. A poorly constructed or managed portfolio will likely fail to live up to expectations. Investors may end up losing to a benchmark index or perhaps see returns tumble into negative territory, destroying wealth.
There are a lot of extra considerations and risks that stock pickers have to tackle. This makes it a far more ‘hands-on’ way of managing money that not everyone is suited to.
Simply throwing money into shares offering a high yield will more likely than not end up underperforming. Don’t forget dividends are ultimately paid at the discretion of management teams. And if a company is starting to struggle, management may decide that the money used for dividends is better kept in the bank to help keep the lights on.
Therefore, when looking to build a high-yield portfolio, investors must always perform the necessary research to make an informed decision. And that’s something our Share Advisor service can help out with.
