It looks increasingly likely that the Bank of England will raise interest rates either in November or December. Yet even with a hike, the base rate is likely to be around a still-low 0.25%. For excess cash that I’m holding, I’m not going to be generating a decent level of passive income from this at all in a savings account. Therefore, if I’m looking to drip-feed £100 each week into passive income ideas, I’d look towards dividend-paying stocks.
Measuring income levels from dividend stocks
I usually measure a dividend stock by looking at the dividend yield. This metric compares the dividend per share against the current share price. If the share price stays the same but the dividend per share increases, the yield also increases. If the share price falls and the dividend per share stays the same, again the yield increases.
The FTSE 100 average yield currently sits at 3.39%, but this ranges from stocks offering 0% through to 11.85% currently. So I have a wide spectrum of options when looking for passive income ideas.
But as a good investor, I should be careful not to just use the dividend yield exclusively in my decision-making. Although it’s the best metric in my opinion, I need to also look at the outlook for the company, the sector it operates in, its level of debt and other similar points.
Looking to maximise the yield
The first think I’d look at for passive income is an ultra-high-yield option. This would carry with it higher risk than normal, but can offer high rewards. With my £100 per week, I’d look to invest in the top 10% of FTSE 100 dividend shares by yield.
Currently, this would give me a range of yields from 6.77%-11.85%. Over time, this could provide me with a high level of passive income due to those generous yields. However, I would only look to invest here if I’m comfortable with the risks.
The risk is that ultra-high-yield stocks are usually that way due to a falling share price that’s artificially pushing the yield up. This could mean that if the company is struggling, the dividend in the future could be cut. Of course, this isn’t always the case, so I would try to reduce this risk by investing in half a dozen or more of these high-yielding stocks.
Building a long-term passive income pot
Another passive income idea would be to target lower-yielding stocks, but those that could offer sustainable payouts for many years to come. There isn’t a guaranteed formula for this, but I can look at the track record of dividend payments to give me a feel of how things have played out in the past.
If I look for yields between 3% and 5% for my £100 a week, I can aim to build up a pot over time. For example, consider if I invested at a 4% average yield for a decade and reinvested the income. At the end of this period I’d have a pot worth almost £14.9k. So by year 11, I’d be enjoying almost £600 of passive income.
This helps to show that even with a relatively modest amount, I can look to put my cash to work via dividend shares.
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jonathansmith1 and The Motley Fool UK have no position in any share 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.
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