There are many ways to create a passive income stream, some harder than others. I think investing in high-yield dividend shares is one of the easiest ways.
Having an initial pot of savings helps to get things rolling. Although it requires some patience and commitment, the compounding gains add up fairly quickly. With only £8,000 to start, monthly returns of £1,000 can be achieved. Here’s how.
Selecting the right dividend shares
Dividends are that little bit extra that some companies pay their shareholders every year. The annual price gains on shares could already provide decent returns – but dividend-paying shares provide even more.
For example, the average annual return of the FTSE 100 since it began is 7%. However, only a few investors achieve that – most average around 5%. When bringing dividends into the equation, a further 4% to 8% can be added on top!
By selecting the right mix of dividend shares, I think it’s possible to achieve an average of around 6% over a long period.
Holding for the long term
Even with a large pot of savings invested into a portfolio of well-chosen shares, it’ll take some time to grow into a decent income stream. Reinvesting the dividends will accelerate the growth.
For example, £8,000 invested into a portfolio with an average 5% return and a 6% dividend yield could grow to £22,995 after 10 years. This amount will pay an annual dividend of around £1,269 a year – just over £100 a month. However, leave the pot for 30 years and it could grow to £190,000, paying out a dividend of £10,491 annually. By the following year, it’ll be paying out almost £12,000 a year – or £1,000 a month in passive income.
And besides the dividend, with £190,000 in savings, I could withdraw £1,000 a month for 15 years. That would make for a comfortable retirement on top of a standard pension.
Which dividend stocks pay 6%?
Yields and prices frequently change, so over 30 years, a portfolio requires some management. Occasional buying and selling may be necessary to maintain the average yield and returns. However, for the sake of an example, I’ll consider one stock that fits the bill today.
National Grid (LSE:NG.) currently sports a 5.6% dividend yield. Although recent growth has been lacklustre (down 10% in a year) the share price is up 140% in the past 20 years. Tasked with implementing and maintaining the gas and electricity network across the UK, it’s likely to remain in high demand for the foreseeable future.
However, since the company must follow strict government regulations on pricing, profit growth can be slow. It’s also faced some hiccups recently, particularly in its US operations. It’s been accused of manipulating efficiency and overcharging customers in Rhode Island and had activists question the safety of a new pipeline in Brooklyn.
But most importantly, dividend payments have been stable for the past 10 years, with yields steadily increasing. Dividends appear well-covered, with earnings at 69p per share and a dividend per share of 57p.
This is the key information to look for when considering stocks for a dividend portfolio. I don’t have the capital right now but if I were buying shares for a dividend portfolio today, National Grid would be on my list.
