With interest rates increasing, the income I could make from a Cash ISA has jumped this year. At the moment, I could get almost 4% from some providers if I locked up my cash for a year. Even though some might pick this option, I’m still putting my spare cash into dividend stocks to enhance my passive income potential. Here’s how and why I’m doing this.
Why I’m picking dividend shares
On the face of it, I might seem a little strange to pick stocks over a Cash ISA. After all, my risk on my capital with the ISA is almost zero. The income is also virtually guaranteed. In comparison, when I buy a stock, my capital is at risk as the share price fluctuates. My dividend is also paid out of company earnings, so it depends on how the business performs.
This is true, but it ignores the potential upside. Sure, the above can be seen as a risk. Yet what about the other side of the coin? The Cash ISA ties up my funds with no chance of improvement. If I’m smart and pick a company that is performing well, I could easily eclipse the return over the course of the next year.
For example, I could have invested in Aviva a year ago. The dividend yield at that point was 5.25%. In this period, the share price has also risen by 11%. This isn’t just one isolated example either. There are plenty of income stocks with yields greater than a Cash ISA that also have enjoyed a rising share price in the past year.
How I can build lifetime passive income
One aim of mine is to be able to enjoy a minimum passive income of £650 a month for the rest of my life. I’ve figured that this amount of money would cover all my expenses of a holiday abroad each month.
Before I start booking flights, I need to invest and reinvest my dividends over a period of time. I’ve figured that if I buy stocks (such as Aviva), I could average a dividend yield of 5.5%. I’m also going to assume that my pot will grow at a rate 4% a year just from capital appreciation (which isn’t guaranteed). This is arguably a conservative estimate, but I’d rather not overestimate.
By putting in £250 a month, I’d be able to reach my goal after 18 years. From that point onwards, even if I assume the portfolio doesn’t gain any further value, I’d still be able to enjoy £650 a month from the dividends paid for the rest of my life.
Clearly, planning that far into the future does come with assumptions. I’d have to sell a stock if the dividend was cut years down the line and replace it with another. Yet this isn’t a deal-breaker for me when I look at the bigger picture.
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. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
This post was originally published on Motley Fool
