A stock market correction is often seen as a bad thing. But when the stock exchange board turns red, whether that is bad or good can depend on one’s perspective.
I see a stock market correction as an opportunity for me to boost my passive income streams. Here is how.
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The concept of dividend yield
When a company pays a dividend, it usually declares it in absolute terms. For example, at the moment the Tesco dividend is 10.9p per share. That means that, for each Tesco share I own, I would stand to earn 10.9p per year in dividends. That is not guaranteed: dividends can rise or fall. But for now at least, the Tesco dividend is 10.9p per share.
So, how much do I need to spend to get that 10.9p? The Tesco share price is £2.79 at the moment. So, for each £2.79 I spend on Tesco shares today, I would hope to earn 10.9p each year in dividends. That is an annual return of 3.7%. We call that the dividend yield.
But if the share price falls, the yield will rise even though the dividend itself has not changed. In other words, I should earn a higher return on my investment.
Dividend yields and passive income
How does that help my passive income?
In short, a higher yield should increase my passive income streams. If I invest £1,000 at a 3.7% yield, I would hopefully earn £37 in annual passive income. But if I can get a 5% yield, that figure would be £50. At a 7% yield, my passive income should be £70 a year — almost double what I could earn from Tesco at its current share price.
That is why some people try to boost their passive income streams by investing in high-yielding shares. But buying shares just for their high yield is not the way I like to invest. After all, the high yield may reflect elevated risk. For example, the City may mark a company’s shares, not believing a changing business environment will allow it to sustain its dividend.
But if an income share I would already consider for my portfolio, such as Unilever or Direct Line, sees its share price fall, that could give me the opportunity to benefit from a higher yield than if I had bought those same shares earlier.
Passive income wishlist
Over the past year, Unilever shares are down 13% while Direct Line has fallen 18%. That means I can get a higher dividend yield from both of them than if I had bought the shares 12 months ago.
On top of that, both companies have raised their dividends in the past year. That does not mean they will keep growing their dividends. Risks such as inflation and pricing competition could eat into profits and lead to a dividend cut. But a stock market correction could push down the price of shares I think are already good passive income ideas – and increase their yields.
That is why I think now is the perfect time to make a list of shares I reckon could make good passive income ideas for my portfolio. If a falling stock market pushes up their dividend yields, such passive income ideas could be even more lucrative for me than before!
This post was originally published on Motley Fool
