Many people dream of earning passive income while sleeping but few understand the specific strategies to reach that goal.
There’s actually a wide range of options, some that are fairly easy and others extremely difficult. Setting up a business, for example, can be lucrative, but it’s risky and takes a lot of initial time and effort.
Investing in dividend stocks is much easier but still involves time, money and a side order of risk.
Right now, the UK market looks like a great place to get started. For a rare moment in history, the FTSE 100 is outperforming the S&P 500 over a 12-month period.
Yet there are still many high-yield dividend stocks selling at discount prices.
Grab your calculator
Ok, so £15,000 a year — that’s a hefty chunk of passive income. How many dividend stocks are needed to achieve that? Well, dividends differ from stock to stock but we can get an idea of their value from the yield. This is the percentage each one pays on the share price.
A £100 share with a 7% yield pays out £7 each year and a portfolio of shares worth £20,000 with a 7% yield pays out £1,400.
A few quick calculations tell me that about £214,000 is needed to return £15,000 a year.
That’s a lot of dividend stocks!
Which stocks might be best?
In my portfolio, I try to aim for stocks with yields between 5% and 9% so that my average yield is around 7%. I think this is a realistic target for the average investor.
Take Legal & General, for example, with its 9% yield. It’s quite possibly the most popular dividend stock in the UK — and for good reason. It has a very long history of proving its dedication to shareholders by consistently increasing dividends.
For income investors, this is usually the most important factor. When a company cuts or reduces dividends, it can devastate a passive income strategy. L&G never misses a beat, raising dividends by around 5% to 20% every year.
Yes, it has some risks (as do they all). For example, as an asset manager, it’s heavily exposed to market movements — if asset prices slump, so could its share price.
To help counter this, it regularly buys back its own shares to boost the stock’s value. Currently, it’s planning a further £500m on top of a previous £1bn.
But it’s just one stock worth considering. Other good examples include Aviva, HSBC and Imperial Brands. Building a portfolio of 10 to 20 similar high-quality dividend stocks is the first step in this strategy.
But what about the £214,000?
That’s the slow part. To reach that goal requires regular investment, patience and compounding returns.
Say an investor puts £300 a month in a 7% portfolio with moderate 4% price appreciation. Even with dividends reinvested, it’s going to take over 20 years to reach £214k.
But as they say — time is money. So get started as soon as possible and who knows, maybe one day both time and money will be available in abundance!
Here at The Motley Fool we’re always exploring new and exciting ways for investors to achieve their passive income dreams.
