Building a passive income is a financial goal shared by many. After all, who doesn’t love the idea of making money without having to lift a finger?
Several methods are available to achieve this goal, each with advantages and disadvantages. Some popular methods include investing in real estate, or starting a business. Personally, I prefer the lazier option of investing in dividend shares. While it requires some initial upfront research and ongoing monitoring, it’s far less time-consuming.
And the best part is, even if I can only spare £5 a day, I can still unlock this source of long-term wealth. With that said, let’s take a look at how I can build a top-notch passive income portfolio.
Laying the groundwork for a passive income portfolio
The phrase “you need money to make money” is entirely accurate in the world of investing. Fortunately, with trading fees reaching near zero and the invention of tax-efficient accounts like the Stocks and Shares ISA, the stock market’s barriers to entry have fallen drastically.
£5 a day is obviously not a lot of capital to work with. But across a whole year, it’s the equivalent of £1,825, which is more than enough to get started. With capital in place, it’s time to start planning out my buying activity.
As wonderful as it would be to buy a new income share every day, that may not be possible (due to the stock price) or sensible (due to trading commissions). And even commission-free platforms have hidden fees in the form of bid-ask spreads.
Instead, I will let my capital build into a nice lump sum. After about 60 days, or two months, I’ll have around £300 to work with. A typical commission fee is around £10 per trade, so I’ll need to generate a return of just over 3% before my passive income investment will start building wealth. And given the average dividend yield sits around 4%, that should be more than doable within a year.
Of course, I’m assuming the stock price doesn’t drop. And as we’ve all seen in 2022, even the best dividend companies on the London Stock Exchange can fall.
A lot of this is just short-term volatility. And solid, high-quality businesses will undoubtedly be capable of weathering the storm. But the question now becomes, how can I identify these winning investments?
Finding the best dividend shares to buy and hold
When it comes to picking passive income stocks, there are some checks that I’ve found quickly eliminate poor-quality investments from consideration.
- Does the company generate free cash flow to cover the dividend expense?
- Have dividends been growing consistently over the last five years?
- Does management have a sensible long-term growth strategy?
If the answer is ‘no’ to any of these questions, it may be prudent to look elsewhere for passive income opportunities.
There is much more to consider than just these three questions before making an investment decision. But it’s a good place to get started, I feel. And once a list of good-looking passive income stocks has been built, I can narrow down my selection across 15-20 stocks to leverage the power of diversification when building a killer passive income portfolio.
