In my opinion, buying equities for dividend income is one of the most straightforward ways of producing a passive income.
That is why I own a portfolio of income stocks. I have been buying these shares to generate a passive income with dividends. My overall aim is to create £1,000 a month in earnings.
Unfortunately, this will not happen overnight. It could take some time for me to build a pot big enough to generate a passive income of £1,000 a month.
According to my calculations, for an income of £1,000 a month or £12,000 a year, I will need to build a portfolio worth £200,000. That is assuming I can buy stocks with an average dividend yield of 6%.
Investing for growth
To hit this target, I have been acquiring growth stocks. This might seem counterintuitive. If I am looking for income, growth stocks are usually the last place to look. Many companies focusing on growth reinvest all of their money back into the business rather than distributing profits to investors.
However, by focusing on growth companies, I believe I can achieve a higher return on my investment initially. This could help me to hit my £200,000 dividend income portfolio target in a shorter time frame.
I believe a 10% per annum return by investing in companies such as Games Workshop and Bunzl. Both of these businesses have robust competitive advantages. These advantages allow the businesses to earn above-average profit margins. They can reinvest these profits back into growth initiatives such as acquisitions and new production facilities.
Of course, there is no guarantee these businesses will hit my return target. Any number of factors could hold back growth. Challenges such as inflation, competition, and supply chain disruption could all hit profit growth over the next few years.
Still, if I can hit my return target, I estimate I will only need to put away £1,000 a month for 10 years to build a nest egg worth £200,000.
A switch to dividend income
When I have hit the target, I can switch from growth to dividend income. To hit my £1,000 monthly goal, I will be targeting companies like Phoenix Group. This life insurance policy manager handles its assets to generate cash for investors and reinvest in growth. Thanks to this policy, the stock currently offers a dividend yield of more than 6%. This is why I believe the corporation is one of the best income stocks available on the market today.
That being said, as dividend income is paid from company profits, it can never be taken for granted. This does not just apply to Phoenix. Any enterprise that delivers a dividend to investors might have to reduce its distribution if costs rise significantly and profits drop. That is one of the significant risks with investing for dividend income.
Despite this risk, I believe the strategy outlined above can help me hit my income goals. That is why I plan to follow this approach over the next decade.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has recommended Bunzl and Games Workshop. 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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