When I was much younger, it was always drilled into me to save save save. When I began learning about investing, I learnt about the importance and value of building up a passive income stream.
I reckon it’s possible to achieve this through carefully investing in dividend-paying stocks, as well as the magic of compounding. Let me explain how I’d tackle this challenge.
Rules of engagement
To build an additional income stream, a Stocks and Shares ISA looks like a great investment vehicle for me. A big reason for this is because I don’t want to surrender my dividends to the tax man. Plus, the ISA offers me an annual allowance of £20K.
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When I’m looking for the best dividend stocks, I need to do lots of research, and ensure I’m picking those with the best chances of maximum returns, as well as consistent payouts. I’d look at things like past track record, industry standing, and future prospects, to name a few.
Let’s say I’ve got £10K tucked away I want to put to work. On top of that, I’ll put in £200 from my wages each month. If I can bag an 8% rate of return over the next 25 years, my initial £10K and monthly additions would leave me with £263,607.
Next, I’d draw down 6% annually, and split that into a weekly figure, which would leave me with £304.
From a risk perspective, it’s worth remembering that dividends are never guaranteed. They’re paid at the discretion of the business. Next, it’s crucial to take into account individual risks for each stock I pick. Finally, although I believe an 8% rate of return is achievable, if my pot yields less, I’d be left with less money at the end of my plan.
One stock I’d love to buy for this plan
I reckon FTSE 100 banking giant HSBC (LSE: HSBA) is the type of stock that could help me achieve my aims.
The average dividend yield for the FTSE 100 index is closer to 3.8%. HSBC shares offer a yield of 7.2%!
Next, the shares look good value for money on two key metrics I use to value stocks. They trade on a price-to-earnings ratio of seven, and on a price-to-earnings growth (PEG) ratio of 0.7. For the latter, a reading below one can indicate value.
HSBC’s impressive vast presence, as well as previous track record help my investment case. Although the past isn’t a guarantee of the future, I’m more excited about its future prospects.
The business has an excellent presence in Asia, and this key growth market could be the key to keep juicy dividends flowing for years to come. With wealth in this region tipped to rise, HSBC is in a perfect position to capitalise.
However, there are issues that could hurt earnings and returns. Potential growth in Asia could be hurt by economic volatility, especially in one of the world’s largest economies, China. Growth issues here have led to recent volatility, and this could slow HSBC’s progress in the future.
