Imagine earning £2,000 in monthly passive income from a portfolio of dividend shares. That sounds rather appealing to me!
But if I started investing in the stock market for the first time at 30 with nothing in the bank, could I still achieve this goal?
Yes, I believe so, thanks to the power of compound returns, which Albert Einstein reputedly dubbed the “eighth wonder of the world“. Let’s explore how this mathematical phenomenon works in practice.
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?
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Buying dividend stocks
First, I need to select dividend shares to buy. There are plenty of attractive options in the FTSE 100 and FTSE 250, as well as overseas investment opportunities.
I like to spread my portfolio across a variety of companies and sectors, mixing riskier high-yield opportunities with Dividend Aristocrats that have more reliable track records of delivering passive income.
Examples of stocks on my watchlist include:
| Stock | Dividend yield |
|---|---|
| AbbVie | 4.3% |
| Altria Group | 8.4% |
| Diageo | 2.2% |
| Investec | 7.3% |
| ITV | 7.4% |
| Vodafone | 9.8% |
If I invested in these shares, I’d have exposure to a range of industries spanning pharmaceuticals, tobacco, alcoholic drinks, banking, media, and telecommunications.
A compounding snowball
With target companies in mind, here’s how a dividend investment strategy can yield long-term rewards.
I’ll need to start with a clear savings goal. For this illustration I’ve chosen a £250 monthly contribution — or a little over £8.20 a day. By adopting a disciplined approach, I think this is achievable.
Plus, I could take advantage of tax relief on pension contributions, if I were to invest in a self-invested personal pension (SIPP), to make the journey a little easier.
By reinvesting my dividends, I’d target a 7.5% compound annual growth rate on my portfolio. If I achieved that rate of return, the value of my stocks could balloon over time.
| Year | Contributions | Portfolio value |
|---|---|---|
| 5 | £15,000 | £18,133 |
| 10 | £30,000 | £44,165 |
| 15 | £45,000 | £81,538 |
| 20 | £60,000 | £135,192 |
| 25 | £75,000 | £212,218 |
| 30 | £90,000 | £322,800 |
| 35 | £105,000 | £481,544 |
As the numbers above show, time is my friend when it comes to harnessing the power of compound returns.
Starting with zero savings in the bank at 30, I’d end up with a portfolio worth over £480k by the time I’m 65. That’s over 4.5 times the amount I’d contribute during the wealth-building process.
If I secured an average 5% dividend yield from my stocks, I’d earn a little over £24,000 in annual passive income after 35 years!
Investing risks
There are risks associated with dividend investing though. In reality, it’s unlikely I’d enjoy a 7.5% annual growth rate every year as there will inevitably be periods of underwhelming stock market returns over a 35-year timeframe.
In some years, I might benefit from higher gains, but in others I’ll have to stomach losses. Volatility of this nature could delay my progress towards my final goal. Plus, my 5% target yield isn’t guaranteed as companies can cut or suspend their dividends, even if they’ve had unblemished records in the past.
Nonetheless, without taking on some risk, I won’t reap the potential rewards. Via diversification and careful stock picks, I can try to mitigate these risks. And, if all goes to plan, I’ll be earning a £24k annual passive income stream from a standing start.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
