Building a passive income stream in the stock market takes time. After all, the average dividend yield of the FTSE 100 sits at around 3-4%. And if I wanted to replace a salary of £30k a year, I’d need to have a roughly £750k portfolio.
With the UK’s flagship index historically delivering an average 8% annualised return, it would take roughly 30 years to reach this milestone if I invested £500 each month. But following last year’s correction, investors now have a rare opportunity to drastically accelerate this timeline. Here’s how.
Stock market recovery
After a roaring couple of years following the 2020 pandemic crash, inflation crept up and investors unsurprisingly got spooked. Subsequently, most of the gains were wiped out, resulting in a sustained market downturn not seen in over a decade.
For most investors, 2022 was a rough year. That was especially for those who decided to pull out of the market near October. Why? Because since then, shares have been on the rebound, with both the FTSE 100 and FTSE 250 up by near double digits.
Despite the recent upward trend, plenty of leading passive income stocks have yet to see their valuations recover. In fact, with UK inflation lingering, stock prices in sectors like real estate and industrials have started moving in the wrong direction again.
However, stock market recoveries are rarely a straight line. And for prudent investors focused on the long run, this latest bout of volatility has only extended the opportunity to bag high-quality income stocks at a discount. Apart from greater potential for share price gains in the future, it also means that a higher dividend yield can also be locked in.
Building a passive income portfolio in 2023
As tempting as it may be to load up on industry leaders offering a high yield, some caution is required. Just because an income stock has been falling doesn’t make it a bargain. Similarly, if a share price is on the rise, that doesn’t mean it’ll continue to do so in the future.
Investors need to spend time closely studying what’s driving the upward or downward momentum of a stock price. Is it because of a general slowdown within a sector caused by temporary external forces? Or is the company facing internal turmoil within its financial position?
Particular attention needs to be placed on free cash flow. In the end, the excess cash created from operations is what funds shareholder payouts. And if it looks like cash flow is being squeezed, dividends may be next, potentially compromising an investor’s passive income stream.
The bottom line
It’s still unclear when the stock market will recover from last year’s downturn. Over in the US, the S&P 500 recently achieved a 20% gain on its October lows, marking the start of a new bull market.
However, such results have yet to emerge here in the UK. And that suggests investors still have plenty of opportunities to snap up cheap dividend stocks to build a passive income portfolio.
