When buying dividend shares, it’s tempting to purchase the highest-yielding stocks to generate the largest passive income possible.
However, this strategy can cause a couple of issues. First, high-yielding stocks could struggle to afford their current payouts because of financial challenges. Second, high-yielding stocks may not offer strong dividend growth. This could make them less attractive over the long run.
As such, focusing on the reliability of dividends alongside their growth prospects could be a means of securing financial freedom via income stocks.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Buying dividend shares with a robust passive income
A reliable income from dividend shares is likely to be a key part of achieving financial freedom for most people. For example, a consistent income provides security. By contrast, a volatile income can mean budgeting challenges that impact negatively on the quality of life.
As such, it’s important to check whether a company can afford its dividends in a variety of market conditions. One means of doing this is making sure they are covered by profit. This means that if sales fall due to weak operating conditions they’re less likely to affect the dividend.
Furthermore, considering whether a company’s business model is highly correlated to the performance of the economy could be a shrewd move. Defensive stocks that provide greater resilience in times of economic uncertainty could be more attractive than cyclical businesses.
Purchasing dividend stocks with growth potential
In order to achieve financial freedom, it’s important to have a passive income from dividend shares that grows by at least as much as inflation each year. If it doesn’t, an investor may find their spending power is gradually reduced. Over time, this can mean an individual’s lifestyle is severely impacted. Especially since a higher rate of global inflation may be ahead because of the loose monetary policies being pursued.
Clearly, assessing the dividend growth potential for any company is subjective. However, by analysing factors such as its long-term industry outlook, market position and strategy, it’s possible to build a picture as to whether it’s likely to provide a growing passive income to its investors in the coming years.
Holding cash for emergencies
Inevitably, there’ll be times when an investor requires access to cash that’s above and beyond the passive income they receive from dividend shares. For example, this may be due to unexpected one-off repairs to a house or car. As such, it’s important to have some emergency cash available for these kinds of situations.
This doesn’t mean relying on cash for a return. However, it does mean having some savings in place that can supplement an income from dividend shares when needed. This can help an investor to enjoy greater financial freedom, with less worry, in the long run.
