Passive income is one of the most appealing uses for investing in dividend shares. As long as I’m on the share register with enough time to spare, I can simply wait until the payment date for the dividend to be received to my account. If I can build up a portfolio of several dividend stocks then this allows me to get a stream of money coming in over the course of the year.
Points I need to think about
I’ve got one eye on next year already and so I want to plan ahead to try and see how I can generate decent passive income. The starting point for this is deciding how much I can afford to invest. This will tell me if I’m being realistic or not in my thinking. After all, I can’t expect to make four figures next year if I can only afford to invest a few hundred pounds over the course of the 12 months.
The other point that will dictate if I can reach my aim is my risk tolerance. As a general rule, the higher the dividend yield of a stock, the higher the risk. One reason for this is that the share price of the company might be falling. With the dividend per share staying the same, a lower share price will boost the dividend yield. Yet the risk is that the price is falling because the firm is struggling. It could see the dividend cut next year as a result.
This doesn’t mean that I need to look for the lowest yield possible. I’d really struggle to hit my goal in that case. So a balance is needed here in picking stocks with some risk involved, but not an excessive amount.
More passive income from being patient
The current average FTSE 100 dividend yield is 3.55%. The highest yield offered right now is 13.39%, with several stocks offering a 0% yield. I think there are some good dividend stocks that I can buy that sit in the 5%-7% range.
For simplicity, I’m going to assume each month has four weeks, meaning that my £100 per week adds up to £400 a month. This means that by next year, my investment pot will be valued at £4,800. With a 6% yield, this will have made me just over £140 in passive income.
This amount might be enough for what I was looking to achieve. However, from my point of view, I’d want to be seeing more than this. What I’d be happy to do is sacrifice some passive income from next year if it means that I can have a lot more a few years down the line.
For example, I’d be happy to reinvest the money I make next year back into dividend shares. If I did this for four years, I’d have a pot worth around £21,800. Then in year five, I could enjoy the passive income, which would work out at just over £100 a month.
Overall, I can make passive income next year with just £100 a week. Yet, I’d much prefer to invest for the longer term to enjoy greater benefits down the line.
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Jon Smith 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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