Early retirement isn’t just something that’s reserved for the elite few in society. With some carful planning, it’s something that’s possible for almost anyone. One of the ways I’m trying to achieve this is by generating (and compounding) passive income from stocks I own.
The strategy behind this is fairly straightforward. If I see a stock with a sustainable dividend payout, I’ll buy it. Then, when I receive the passive income from the dividend, I reinvest it into the stock. That way, I increase my holding in the company and increase the size of the next dividend payout. Over time, I’ll end up with a portfolio of several stocks, all paying out income.
As I’m reinvesting the passive income I make from the stocks, my overall value should increase year by year. Depending on the amount I invest and the number of years left to accumulate, this can enable me to retire earlier than planned. If you have a decade or more as your investment timeline, this can cut your retirement age significantly.
UK stocks to achieve my aim
First up is Rio Tinto, the large metal and mining company. At present the dividend yield sits at 4.50%, comfortably above the average FTSE 100 yield of 2.84%. The business has been publically listed for decades, with a market capitalisation of over £77bn. This makes me comfortable to be able to invest and know that Rio Tinto is still going to be around when I come to retire.
The company has a generous dividend policy, stating that the “board expects total cash returns to shareholders over the longer term to be in a range of 40-60% of underlying earnings”. The dividend cover sits at 1.6, giving me confidence in the ability of the dividend to continue to be paid. Any figure above 1 is healthy, and shows that the business has enough earnings to pay out the dividend amount.
Another veteran of the FTSE 100 for passive income generation from stocks is National Grid. As a utility company, dividend income is a way to keep investors happy. This is because the nature of the industry is mature and not growing at a fast pace. Therefore, a rise in operating profit in 2020 of 13% for National Grid is very impressive.
This trend might not continue. Yet I’m fairly confident in the knowledge that National Grid is unlikely to suffer large financial setbacks in the near term. The contracts it holds and the long-term investments it’s making across the network should enable it to continue paying dividends.
High passive income from a surprise stock
I recently wrote about Diversified Gas and Oil, with a dividend yield of 9.5%. This enables investors to pick up a high level of passive income relative to the amount of stock bought. The dividend amount rose by 7% last quarter, and the quarter before. Large amounts of free cash flow are being generated, allowing such a payout. I’m cautious on the stock, but feel a small allocation here could yield potentially high rewards.
Overall, I think the above three UK stocks are all good examples of how dividend income can be obtained right now. With the right reinvestment strategy, I’m hopeful of early retirement.
jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.