When targeting a high passive income, an investor needs to tweak their strategy for buying dividend stocks. Depending on the time horizon, the risk likely has to be increased as well. But when we put everything together, it’s by no means impossible to target four figures in dividend income per month. Here’s how.
Bumping up the yield
For income investors, a dividend yield of around 4%–5% is arguably the sweet spot for sustainable income without entering high-risk territory. This can be increased to 5%–7%, but the scope to find a diversified portfolio of companies starts to thin out a little.
Yet when we’re talking about generating a sizeable amount of income, ideally, an investor will be looking to buy stocks with a yield in excess of 7%. This is because it can allow the portfolio to compound at a faster rate, making the existing money work harder, and ultimately reducing the time it takes to reach the income goal.
Of course, buying UK stocks with yields above 7% can mean there are some risky companies that might not be able to sustain the same level of payouts for years to come. But there are still some gems out there with high, sustainable yields.
Talking figures
In terms of numbers, let’s say an investor can spare £1,000 a month. I’ll assume an average yield of 8%. If this were kept up over time, the portfolio would pay out an average of £2,999 monthly just after year 17.
Of course, this might seem a long way away. If the yield was increased to 10%, this time would fall by two years. Or if the yield was kept at 8% but £1,500 was invested each month, it would take just under 14 years.
A good example
In terms of a stock that could be considered, there’s AEW UK REIT (LSE:AEWU). The stock is down 1% in the last year and has a dividend yield of 7.86%.
The real estate investment trust (REIT) owns a portfolio of commercial properties across the UK. Rather than building properties from scratch, the company focuses on buying undervalued assets, improving them as needed, and collecting rental income from tenants. REITS also have tax advantages.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
The business model is fairly simple, as the firm makes money by owning property. Tenants pay rent, and after operating costs and interest expenses are covered, much of that income can be distributed to shareholders as dividends.
One reason the dividend looks attractive is that it is supported by recurring rental income. Unlike a traditional company where profits can swing dramatically depending on sales, property owners often have long leases that provide visibility over future cash flows. Evidence of this was seen in the latest quarterly update, where “for the 42nd consecutive quarter” the board approved the 2p dividend per share.
It’s true that one risk is the cost of debt. The REIT has to take on borrowings in order to finance new projects. However, the current fixed rate of interest as of May is 2.96%. This is low relative to the base rate of 3.75%, so it’s managing the risk well for the moment.
Overall, I think it’s a good stock to consider for investors looking at this income strategy.
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Jon Smith has no positions in the shares mentioned.
