Building a passive income stream is arguably one of the most common financial goals. After all, who doesn’t love the idea of making money without having to lift a finger.
There are lots of different ways to get started tackling this objective. But most, such as starting a business or becoming a real estate mogul, require considerable starting capital. Investing in the stock market is slightly different.
It’s true investors will still need a large portfolio to make any meaningful income. But the journey to get there can be launched with just £25 a week. Here’s how.
Building passive income from scratch
To kick off an income portfolio, an investor first needs money to make their first purchase. Fortunately, we live in a time of technological and financial innovation where the cost of buying and selling stocks is extremely low, from as little as £5 per transaction.
But even at this level, if I’m consistently investing £25 a week, it creates a problem. That’s because £5 out of £25 is 20%. In other words, I would need to generate a 20% return on investment before breaking even. So clearly, a smarter approach is needed.
Instead of investing money each week, let’s put it into a savings account until a more substantial sum has been accumulated. A benefit of the recent interest rate hikes is that many savings accounts are currently offering around 4% interest, so investors can still earn while building a lump sum of capital.
After about three months, investors will have around £325 saved up (excluding any interest earned). And now, to break even, a passive income investment only needs to generate a 1.5% return – far easier to achieve.
Finding the right dividend stocks
Since the objective is focused on income rather than growth, dividend stocks will likely be the ideal investment target. These are companies that have typically reached a state of industry maturity.
As such, they’re not likely to deliver skyrocketing share price gains. But they also have a habit of returning excess generated cash to shareholders via a dividend. And in the long run, this can more than make up for it.
Dividend stocks exist in almost every industry, giving investors plenty of room to diversify. However, it’s essential to understand that dividends, unlike interest payments on debt, are not mandatory. These are optional payments made at the discretion of the management team. And consequently, there are countless examples of firms cutting or suspending shareholder payouts.
Needless to say, a dividend cut will be bad news for a passive income portfolio. So how can investors avoid this situation? There’s always an element of risk when it comes to investing. And sometimes companies can become disrupted through no fault of their own – just look at travel stocks in 2020.
However, the risk of being exposed to a dividend cut can be mitigated by carefully examining a business’s cash flow. This is what ultimately funds shareholder payouts. And dividends often follow if a group has a consistent track record of expanding revenue and earnings.
