Even with very little savings, I aim to retire in 25 years with a decent passive income stream. In addition to my pension, it can help me live a comfortable and rewarding life well into old age.
But building a second income stream that doesn’t require daily work is no easy feat. I’ve found one possible way to achieve this is through slow and steady investments in stocks that pay high dividends.
I think of dividends like a reward I get every for my committed investment – a present to say thanks. Since it took time and effort to earn the money I invested, it deserves some return. But I have to make good choices or my reward might be worth nothing.
The first step is choosing the right shares.
A reliable high-yield dividend stock
I believe HSBC (LSE:HSBA) is a good example of the kind of dividend stock that I can rely on to pay me regularly. I also think it’s the kind of company that isn’t going to go under any time soon – after all, it’s one of the biggest banks in the world!
I’ll admit, the share price doesn’t provide quite the same excitement as a growth stock like Rolls-Royce. In the past five years, it’s down 0.27%. But unlike Rolls-Royce, HSBC boasts an impressive dividend yield of 7.34%. Even if the share price goes nowhere, I still earn that percentage extra per year on every share I own.
That is, so long as the company doesn’t cut the dividend. So I must choose stocks with a reliable track record of making dividend payments. Besides an understandable pause during the pandemic, HSBC has been making fairly consistent dividend payments for almost a decade.
On the downside, it’s a bank and bank shares tend to suffer during economic crises like a recession. So there’s some risk that the investment could lose more money than the dividend pays out. For that reason, it’s important to diversify an investment into shares across several different industries.
Don’t miss those tax savings!
Another way to ensure I make the most income is by minimising my tax obligations. I’m not planning a move to the Cayman Islands any time soon, but fortunately, I won’t need to.
By opening a Stocks and Shares ISA, I can invest up to £20,000 a year without paying any tax on the gains. That can add up to a lot of extra savings when considering compound gains. Even a £100 tax break a year can equal a lot of extra returns over the space of 25 years.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Keep compounding
Finally, it’s important to build up to a passive income stream by compounding returns – reinvesting the dividends and regularly adding to the investment.
For example, £8,000 in a portfolio with an average 7% annual yield and an expected annual price increase of 5% could reach £25,260 after 10 years. That would pay an annual dividend of only £1,618. But if I invest a further £200 a month on top of the initial £8,000, it could reach £67,760 after 10 years with an annual dividend of £4,186.
After 25 years, the magic of compound returns means it could balloon to £471,000, paying an annual dividend of £30,000.
