Income investing has become a very popular strategy in recent years. Low interest rates in the UK (cut down to just 0.1% earlier this year) mean that having cash sat in a savings account isn’t enough to counter inflation. If I received 0.1% interest but inflation was at 1%, the value of money was losing 0.9%. Such idle cash needs a better home to work harder.
As an alternative, investors like myself bought stocks that paid out a regular dividend. This income can be calculated to work out a dividend yield. Despite several large businesses cutting dividends in 2020 due to the pandemic, the average FTSE 100 dividend yield is still above 3%. But how did I make the jump into trying to get rich from income investing?
Work out numbers and yields
Firstly, I’d work out how much I can afford to invest in dividend paying stocks. There’s no point having a dream of making £100,000 in dividend income per year (enough to tick the box of getting rich) if I can only afford to invest £100 a month. Situations do change over time, but it’s important to be realistic in terms of how much I can invest. As the investments will be in stocks for the long term, the aim would be not to sell in the short term.
Second, I need to figure out how much risk I’m comfortable taking on for income investing. The higher the dividend yield, often the more risky the income payout. Earlier this year, some stocks had a dividend yield in excess of 10% due to falling share prices. Ultimately, a lot of these companies had to cut the dividend payouts, reducing the yield. By contrast, Severn Trent and Admiral have yields around 4%. This is much lower, but both companies have what I would call ‘safe’ dividends that are unlikely to be cut.
Reinvestment to boost income investing returns
Once invested in income stocks, things don’t stop there. I’ll be receiving income payouts on a regular basis. In order to boost my chances of getting rich, I’d reinvest the dividends to begin with. This builds up my overall investment pot even without me putting any new money in. Over time, the reinvested income can start to add up.
My fourth step is to be active on the stocks that I own. As 2020 has shown, share prices can be very volatile. Let’s say I bought a stock with a 5% dividend yield. One year later the share price has risen by 20%. I’ve seen another stock that has an attractive 7% dividend yield, with an undervalued share price. There’s nothing wrong in taking profit on the existing share and reinvesting in the other stock. Taking advantage of such opportunities can help dividend investing in the long term.
Finally, the last step for income investing is to remember it’s a long-term strategy. Although reinvestment can be done regularly, my overall portfolio will take years to grow to a level whereby I can say that I’m rich. There’s nothing wrong with this, and it actually makes it more sustainable than other quick wins.
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jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has recommended Admiral Group. 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