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How I’d build a portfolio to make a passive income from dividend shares

Peter Stephens
·3-min read

Making a passive income from dividend shares could be a sound move in 2021. After all, few other mainstream assets can produce an income of 5%+ while interest rates are low and house prices are high.

Through buying shares in a diverse range of high-quality companies with affordable dividends, it’s possible to obtain a sustainable income return that grows at an above-inflation pace over the long run.

Making a passive income with high-quality stocks

It’s tempting to buy the highest-yielding dividend shares to make a passive income. However, they may have high yields due to low share prices caused by weak financial positions. For example, a business may have large amounts of debt that could compromise its future performance. In this situation, it may lack investment appeal. It may also be unable to make its dividend payouts.

Therefore, it’s important to check the quality of a company before adding it to an income portfolio. This may be undertaken by focusing on its annual reports and latest investor updates. That way you’ll be able to gauge its financial strength and the size of its competitive advantage.

Through buying high-quality companies, an investor can reduce their risk and build a portfolio that provides a more reliable passive income over the long run.

Checking dividend affordability

As well as assessing the quality of a company, checking the affordability of its dividends could be a sound means to maximise passive income. A stock with a high yield that’s unaffordable is unlikely to be attractive to any income investor over any time period.

Therefore, analysing a company’s dividends compared to its net profit or free cash flow could be a shrewd move. It may enable an investor to select those companies that offer a greater chance of making reliable payouts. Even if their operating conditions deteriorate.

Given the uncertain political and economic outlook in the UK at the present time, businesses with robust dividends that are very affordable could be more attractive from a passive income perspective.

Diversifying across a wide range of dividend shares

Some companies may offer a more attractive passive income outlook than others. But it’s important to build a portfolio that includes a broad range of businesses. This reduces an investor’s exposure to a small number of stocks. The result is a more robust and sustainable dividend stream over the long run.

Furthermore, diversifying across multiple industries and regions could be a shrewd move. It may enable an investor to reduce their reliance on specific countries or sectors at a time when coronavirus risks are high. As well as reducing risk, this could lead to higher dividend growth in the coming years. Especially if an investor has exposure to a wider range of growth opportunities across the global economy.

The post How I’d build a portfolio to make a passive income from dividend shares appeared first on The Motley Fool UK.

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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.

Motley Fool UK 2020