It has been difficult to generate a passive income in the last decade. The income returns of assets such as cash and bonds have been negatively impacted by low interest rates. Meanwhile, buy-to-let property has become out of reach for many people due to house price rises.
As a result, buying dividend shares through a Stocks and Shares ISA has become an increasingly favoured route for anyone looking to obtain a passive income. Certainly, the risks facing investors are relatively high at present, but there may be opportunities to build a portfolio of dividend shares that can provide a sustainable passive income in the long run.
Defensive shares
While investing in companies that offer high growth potential may seem like an exciting prospect, defensive stocks could offer a more reliable passive income. They may, for example, be able to better cope with economic instability, as well as benefit from changing investor sentiment.
As such, buying stocks that have demonstrated a track record of profitability less closely correlated to the performance of the wider economy could be a good idea. As well as UK-specific risks, the global economy faces the prospect of a possible trade war that could limit the growth potential of a variety of major economies. Therefore, obtaining a relatively resilient income stream may become increasingly valuable over the coming months.
Solid fundamentals
Identifying companies that can afford to pay their current level of dividends is crucial when seeking to obtain a passive income. There’s little point in buying stocks that have payout ratios that are close to, or above, 100%. In such a scenario, a dividend cut may be required to sustain the company in question.
Therefore, checking dividend affordability and other fundamental factors, such as debt levels and cash flow, could be a sound move. Global interest rates are likely to move higher in the coming years, which could threaten the outlooks of companies that have highly-leveraged balance sheets. Similarly, having sufficient free cash flow to adapt to changing consumer trends and an evolving world economy may become increasingly important over the coming years.
Valuations
The current uncertainty in the stock market could provide opportunities for investors to buy undervalued shares. Historically, this has proven to be a successful means of investing in shares, since it provides a more favourable risk/reward ratio for long-term investors.
Certainly, the prospects for the FTSE 100 and FTSE 250 appear to be difficult to predict in the short run. But through purchasing defensive companies that have strong fundamentals while they trade on low valuations, it may be possible to improve the sustainability of your passive income. When undertaken in a Stocks and Shares ISA, it may offer a tax-efficient investment opportunity that’s more appealing than other mainstream assets at the present time.
