In general, investing plans either involve reinvesting dividends to aim for higher returns over time, or withdrawing them for passive income. But what if you do both?
More specifically, what happens if you invest £1,000 a month in dividend stocks, take out half the cash it returns each year, then reinvest the rest? I think the answer is quite interesting.
Return potential
The question obviously depends on what kind of return you get on your investments. But (for reasons we’ll come back to later), let’s suppose a 6% annual return.
At that rate, a £1,000 monthly investment with half the return taken out and half reinvested turns into a portfolio worth £140,091 after 10 years. And it generates a total of £7,944 a year.
Importantly, you’ll have already taken out £20,091 over that time as passive income to do whatever you like with. And the numbers start to go up sharply from that point.
After 20 years, the total reaches £329,123, has already paid you £89,123, and makes £19,752 a year. By year 30, it’s at £584,194, earns £35,051 annually, and you’ve already had £224,194.
A hybrid plan
Most dividend investing strategies take one of two approaches. They either involve reinvesting to grow returns or taking out the cash generated as immediate income.
The problem with reinvesting is that it means you don’t actually get any income you can spend for years or even decades. And isn’t that the point of focusing on dividend stocks?
The downside to withdrawing the cash is that you miss out on the powerful force of compound interest over time. So your returns are likely to be much lower as a result.
With the hybrid strategy, you stand to benefit from both. You get half of your annual return as passive income you can spend straight away, while the rest grows over time.
6% return
The big question, then, is where to get a 6% annual return? I think there are a few potential candidates, but one that’s worth considering is Primary Health Properties (LSE:PHP).
The firm owns and leases a portfolio of GP surgeries. And as a real estate investment trust (REIT) it pays out 90% of its income to investors, instead of paying tax on it.
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The portfolio has very high occupancy rates and with the NHS as its main tenant, the risk of defaults is low. An ageing population also means I expect this to continue.
There’s a 7.5% dividend yield and the firm has a very good record of increasing its returns over time. So for investors targeting passive income, I think it’s definitely a stock to consider.
Diversification
Primary Health Properties isn’t a risk-free investment (if there is such a thing). Its income depends on what governments decide to do about the NHS and public health.
I don’t see any threat on the horizon in this month’s Budget, but investors aiming for decades of passive income need to look further ahead than this. And this is something to note.
The best way to limit this risk is by building a diversified portfolio. Fortunately, there are plenty of other stocks worth considering right now that I think give investors a chance to do this.
