Income stocks provide investors with a fairly regular secondary income stream. And while the payments aren’t guaranteed, the risk of a dividend cut can be avoided by being more prudent during the stock-picking process. And, given time, a well-managed, intelligently constructed portfolio could yield exceptional results.
Of course, with most stocks only offering a few pence per share, building a meaningful passive income usually requires a considerable capital investment. Fortunately, this doesn’t have to be all in one go. By leveraging the power of compounding, it’s possible to reach something like a £5,000 annual income target, even with modest sums like £5 a day. Here’s how.
Creating a strategy
That £5 a day roughly adds up to around £150 a month. And even for households on a tight budget, making some small sacrifices should be more than sufficient to free up this capital.
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To avoid wasting money paying trading fees, it’s typically wiser to let this money accumulate into a meaningful sum before putting it to work in the stock market. The good news is with interest rates going up, savings accounts are finally offering a decent near-risk-free return right now. And after three months, around £450 should now be ready, with a little extra from any interest received.
On average, the UK stock market has historically delivered a yield of around 4%. But there are plenty of firms offering considerably more. And by being a bit more selective, it’s possible to boost this initial payout to around 5% without taking on any significant additional risk.
Assuming a portfolio can also deliver a further 5% in annual capital gains, this brings the total return to 10%. And investing £450 each quarter at this rate for just under 20 years translates into a net worth of £100,000 – unlocking a £5,000 annual income in the process.
Accelerating the timeline
Obviously, waiting around for two decades is less than ideal. The good news is there are ways to accelerate the process beyond injecting more money. By taking on more risk, it’s possible to achieve a higher initial yield. Even if the payout is boosted to just 6%, that’s enough to wipe out almost two years from the waiting time.
But what can be a far better catalyst to build wealth faster is picking income stocks which have the capacity to grow their dividend payments.
A low yield today can expand into an impressive one in the long run. An extreme example of this from my portfolio would be Safestore. Investors who snapped up shares in 2013 have enjoyed so many dividend hikes that the yield today versus the original cost basis is over 50%!
Risk versus reward
As with anything in the world of stocks, nothing is guaranteed. Dividends are ultimately funded by the company’s excess earnings. And if operations become disrupted, even through no fault of its own, shareholders could see their payments get slashed, or even outright cancelled. Both of these would likely result in the share price taking a nose dive, punching a portfolio in its face.
Nevertheless, suppose investors are mindful and stay within the limits of their personal risk tolerance. In that case, I believe the stock market could have an enormous positive impact on their long-term wealth.
