Having a second cash flow stream that’s separate from an everyday job can be of great benefit to an investor. It provides funds to either reinvest in the stock market, or to use for other lifestyle choices. Whatever the reason, the focus to begin with is on finding a viable way to make the passive cash stream. Using income stocks can be just the ticket.
Weighing up the investment case
Income shares have pros and cons. One of the largest benefits is that the yield potential can exceed that of other traditional investments. For example, at the moment the highest dividend yield in the FTSE 100 is 10.49%. Although the current yield doesn’t mean it’ll stay this high in the future, it goes to show what can be achieved.
Another reason why some like income stocks is due to the flexibility in buying and selling. Unlike some other assets that can generate cash but can take months to sell (such as property), stocks can easily be traded each day. If an opportunity presents itself, a shrewd investor can jump on it straight away and own the stock the same day.
One risk is that dividends aren’t guaranteed. Unlike bond coupon payments, there’s no requirement from the CEO to pay shareholders a dividend. As a result, investors need to be careful about buying a stock under the illusion that future income is definitely going to be received. Should a business get in trouble, the dividend payment could be reduced.
One for consideration
With the aim of building a good pot of income, investors could consider buying HSBC (LSE:HSBA). The global bank has a yield of 6.01%, with the share price up 35% in the past year.
The business is benefitting from both higher revenues and also a drive for lower costs. The latest Q3 results showed revenue up 5% versus the same period last year. Factors that helped drive this included higher client activity in the Wealth Management division as well as volatile market conditions that boosted trading transactions.
At the same time, various reports have surfaced of a likely cost-cutting push this year. If this actually happens, overall profitability could improve, with the mix of rising revenue and falling costs. This could ultimately boost the earnings per share, helping to solidify the dividend payments.
Even though this sounds great, investors do need to be careful. A good chunk of revenue is based on interest income, which is sensitive to a change in interest rate. Should major central banks cut the base rate this year, this could cause interest income to fall.
Adding the figures up
If an investor considers putting £750 a month in dividend shares with an average yield of 6.5%, the investment pot could quickly start to build. If dividends were reinvested, this could compound growth even faster.
After 15 years, the pot could be worth £229.6k. The following year, this could generate £40.90 on average each day. Predicting income this far in advance isn’t an exact science. But it goes to show the potential that does exist with this strategy.
This post was originally published on Motley Fool
