Here’s why I’ve changed my mind about buying dividend stocks for passive income

Can buying dividend stocks for passive income actually work out well for investors? Here’s the unvarnished truth.

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Investing in UK dividend stocks for passive income can be a buy-and-forget strategy.

But does it actually work?

I’ve back-tested the approach using five popular dividend-paying stocks.  

The past few years have been challenging for businesses and shares because of the tough general economic circumstances we’ve lived through.

But that makes a five-year back-test even more useful.

A progressive dividend policy

Energy company National Grid (LSE:NG) often finds its way into dividend-focused stock portfolios.

The firm has been selling off its UK gas assets in a strategic move aimed at tilting more towards electricity. It now has an overall asset base of around 75% electricity, up from 60% in 2021.

One of the ongoing risks for shareholders is the business attracts a lot of regulatory scrutiny, and that applies to its operations on both sides of the Atlantic. It’s possible that requirements for infrastructure investment may change, forcing the company to reduce its dividends.

However, so far, the dividend has grown a little each year since 2019, and City analysts expect further increases ahead.

In November last year, the company said it expects growth in earnings to “underpin” the progressive dividend policy into the future. Then in April, it said underlying earnings per share for the trading year to March 2024 would be in line with the prior year.

We’ll find out more with the full-year results due on 23 May.

But if I’d bought some of the shares five years ago, would it have been a successful passive income dividend investment?

Positive investment returns

In May 2019, the share price was about 835p, and since then the company has paid dividends worth 254.8p.

So that’s an income return of about 30.5%.

However, today the stock is around 1,107p (9 May), so there’s been a gain of around 272p from the share price.

Combining the two means the overall return has been in the ballpark of 63%, less a little to account for trading costs when buying and selling the shares.

I’d consider that a successful investment.

But what about other popular dividend stocks?

Financial services provider Legal & General has fallen by about 25p per share over the five-year period and delivered about 93p in dividends. So, the overall gain was around 68p, or 25%.

Meanwhile, ever-popular stock Lloyds Banking delivered almost 9p a share in dividends but lost 7p on the share price. So, the total return has been about 2p a share, which works out at just over 3%.

In the fast-moving consumer goods space, Unilever has provided a total return of just over 7%, and Coca-Cola HBC’s has been around 16%.

With these stocks, the strategy worked

All those stocks delivered a positive total return over the past five years despite the economic challenges through the period.

If I’d divided money equally between all five stocks, my overall diversified portfolio gain would be just under 23%.

There’s no guarantee of a positive investment outcome over the next five years for these shares.

However, I used to be sceptical about the potential benefits of investing in dividend stocks for passive income. But this exercise has helped me change my mind.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc and Unilever Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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