Dividend stocks are one avenue that I like to use to generate passive income. Passive income enables me to earn money without having to put high levels of effort in. So I can continue to try to make profits from more active stock picking that require more research. When I blend the two together, my overall pot should be able to work harder for me than just doing one or the other.
Passive income from dividend stocks
One element that makes dividend stocks appealing for passive income is the yield. Technically I make passive income from my Cash ISA, but the amount is negligible. For companies that pay out a dividend, the income can be generous.
The way I calculate this is by looking at the dividend per share paid out relative to the price of the share. This is known as the dividend yield. The higher the yield, the more I’m squeezing the lemon.
I do need to be careful about high yields, as sometimes it can be too good to be true. A falling share price might inflate the dividend yield for a period. But the struggling company (hence the share price fall) might have to cut the dividend in the future. This would then reduce the dividend yield.
So to make sure I get sustainable passive income from dividend stocks, I want to be sensible. The FTSE 100 average dividend yield sits just below 3%, which I think is still attractive. By being selective, I’d be happy targeting a yield of 5% without having a very high overall risk level.
Crunching the numbers
With a sustainable dividend being paid out into the future, I can now turn my mind to thinking of numbers. Let’s say that I want to make £100 a week on average in passive income from dividend stocks. It has to be an average as dividends often get paid once or twice a year. Even if I bought a dozen stocks, I’d struggle to get a payment each week!
From here I just need to plug in the numbers and work backwards. I know my yield is 5% and my end goal is £100 a week (£400 a month). For a lump sum investment, I’d need to buy shares totaling £104,000.
This sounds a lot to buy in one go. An alternative way could be to build up to the passive income target from dividend stocks. I could invest £1,000 a month, reaching my end goal just after seven years.
From my point of view, working away at my goal for a few years to avoid a huge drain on my liquidity makes sense. So I’d prefer to do the second option. Either way, I can show that making good dividend income in a passive way is possible.
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jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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 2021