I reckon investing in dividend stocks is a fantastic way to build a passive income stream.
Let me break down some key things I must do when investing to build an additional income.
It’s a trap!
The famous words of Admiral Ackbar (yes, I’m a huge Star Wars fan) spring to mind when encountering high dividend yields. They aren’t always what they seem. I’ll admit I’ve been tempted by ultra-high yields. However, they’re more often than not a sign that a business is in trouble.
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A big reason for a high yield is a firm’s share price falling off a cliff. Some of the most common reasons for this include a dip in performance, financial or regulatory troubles, and market volatility.
I ensure I carry out as much research as possible to understand the level of return on offer.
Mix it up!
Diversification is a fantastic way to mitigate risk. I try to ensure I have a mix of stocks, from different industries and different positions. It can be dangerous to overexpose myself to one industry. I’d look to buy one or two industry leaders or growth stocks from each sector.
Some of the industries I look at include banking, consumer goods, utilities, investment trusts such as REITs, and technology.
Getting my crystal ball out
Let’s be honest, no one can predict the future. However, when investing, I reckon it’s crucial to try and use all the information available to try and make a prediction as to how and where future payouts will come from.
Some of the aspects I review are competition in the market, balance sheets, performance updates, as well as future-proofing of products and services.
Go long!
As a Foolish investor, I buy and hold stocks to build up a pot of money from dividends. Plus, as I want to maximise my money, a Stocks and Shares ISA is a no-brainer due to the favourable tax implications. The magic of compounding can help maximise my money if left there to sit and grow for a period of five to 10 years, at a minimum.
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.
One stock I love
National Grid (LSE: NG.) is one dividend stock I would love to buy when I can.
It makes sure we all have the necessary power to go about our day-to-day lives through owning and managing the electricity grid.
As power is an essential, this offers the stock defensive ability. Plus, it has no competition, which means it’s easier to predict earnings as they’re relatively stable.
At present, the shares look decent value for money on a price-to-earnings ratio of 10.
A dividend yield close to 6% is attractive. However, dividends aren’t guaranteed. This was perfectly demonstrated by National Grid cutting them recently to allocate funds towards maintenance and growth costs.
This is a risk moving forward too. The sizable expenditure required to maintain the grid, as well as invest for future green initiatives, could hurt payouts.
However, for me, the pros outweigh the cons. This is the ideal type of stock I reckon could help me build an additional income stream.
