According to a recent Finder savings survey, the average amount of savings for someone aged 45-54 is £9,402. I’m going to assume that those funds are surplus to normal life expenses. Therefore, if I was in that position, I’d strongly consider trying to make my cash work harder. Even though interest rates are falling, here’s how I could still work towards making a tidy second income via dividend stocks.
Active stock picking
The lump sum of £9,402 allows me plenty of ammunition to split between several shares. The benefits of diversification can be achieved with a relatively modest amount of stocks, such as a dozen. If I did this, it would equate to just under £800 in each idea. This is a good figure in my eyes, as each has the potential to generate me a noticeable amount of income each year.
Some might say that with this money, it would be easier to simply put it all in a FTSE 100 tracker that accumulates the dividends. It’s true that this would give me the element of diversification. But I don’t believe it would allow me to squeeze the most out of the funds.
At the moment, the average dividend yield in the FTSE 100 is 3.55%. Some high-yield savings accounts can pay higher than that, without the risk of the capital falling in value. So I don’t think it makes sense.
However, within the FTSE 100, there are individual stocks that yield as high as 9.39% right now. I’m not saying that I’d buy that particular share, but it goes to show that a smaller selection of stocks can act to increase my yield well above the average.
Banking on it
A good example is HSBC (LSE:HSBA). At the moment, the yield is 7.04%, with the stock up 12% over the last year.
Apart from the blip during the pandemic, the FTSE 100 bank has a long track record of paying out dividends. This makes it really appealing if I was starting this strategy, because I want to reinvest the income to build up my pot over time.
One of the main reasons HSBC can do this is based on its operating model. As a bank, it mainly makes money in the interest margin between the rate it lends at versus the rate it pays out on deposits. So as long as it’s deemed credit worthy and customers trust it, it’ll be able to make money. Of course, this is somewhat of an oversimplification. It can make or lose money in other ways. Yet when you look at the results, net interest income is the driving force behind overall revenue.
It’s true that as interest rates fall, the net interest margin for the bank will shrink. This is a risk, but I’m not too concerned. Lower rates should stimulate demand, fuelling interest in mortgages and loans.
Talking through numbers
If I assumed that I could build my portfolio with an average yield of 7%, my pot would grow quickly. Even without investing more fresh money, after 11 years my pot could be worth £20,260. Of this, £10,858 would have come from dividends. From there, I could look to spend the passive income, or keep building it up.
This post was originally published on Motley Fool
