August is traditionally one of the quietest months on the financial calendar, with many investors and traders taking a summer holiday. Yet this isn’t an excuse to stop making plans or ignoring potential opportunities that present themselves. In fact, given where the stock market is right now, I think it’s a great time to kick-start a fresh passive income stream.
Building up frequent cash payments
The main form of generating passive income from the stock market revolves around dividend stocks. These are companies that pay out a cash dividend to shareholders, usually a couple of times a year.
The dividend isn’t guaranteed, and depends largely on the performance of the business during that period. If profits are high, chances are that the dividend could be juicy. Yet the opposite also applies during a bad year.
In order to generate a stream of income, investors need to hold a diversified group of such shares. After all, holding just a couple could mean going for months without getting paid anything. If this is built up to a dozen or more stocks, then it’s realistic to expect to receive some cash each month.
As a small point, patience is definitely required. Starting this month makes sense, but it’s very unlikely that an investor would receive a dividend payment this month. This is because they’re announced a while in advance, with people needing to already own the stock for a period of time to be eligible.
Dividends versus alternatives
Given that the interest rate here in the UK is at 5.25%, some might wonder if dividend stocks are the best way to build passive income. After all, there’s very minimal risk associated with the capital when it’s put in a savings account or form of Cash ISA.
It’s a valid argument, but I still favour the yields that are available in the FTSE 100 and FTSE 250. For example, there are currently 53 stocks in the FTSE 250 with a yield of 6% or higher. Granted, not all of these are smart buys, but there are definitely enough there to build a strong portfolio. There’s also the potential for the share price to rally, adding to the overall yield.
Getting to six figures
My calculations that got me to the £202k were based on several assumptions. I have to base my projections on an average dividend yield that I think is achievable. Based on the above FTSE 250 data, I’m going to use 6% (which isn’t guaranteed, of course).
The other element is how much to invest each month. This is subjective and varies from person to person. I’m factoring in £435 a month.
If I keep up both the amount and the yield, then in 20 years my passive income stream will have built my investment pot to a value of £202k. Incredibly, by year 20 I could be getting paid almost £1,000 per month just from dividends.
