There are few things in this world more enjoyable than earning cash without lifting a finger. That’s the beauty of investing in dividend shares. The regular payments sent to shareholders feel like free money sent from above.
That’s why I’m on a life-long mission to build a steady passive income stream from dividends.
First, I must build up my portfolio’s value through the miracle of compounding returns. Initially, I can accelerate this process by reinvesting my dividends. I can further optimise my growth with a Stocks and Shares ISA, allowing me to invest up to £20,000 per year with no tax on the capital gains.
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Once the pot is large enough, I can start withdrawing my dividends as income and enjoy a comfortable retirement.
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What’s the catch?
Does the above sound too good to be true? I’ll admit, it isn’t easy — but it is possible! For it to work, three things are required: patience, dedication and a market-beating portfolio of the best dividend stocks in the UK.
Choosing the right dividend stocks isn’t always easy. There are several factors to consider, like the yield, payout ratio, and dividend growth history. It’s equally important to assess the financial stability of a company by checking its debt and cash flow.
The ideal dividend stock has strong cash flow, a sustainable payout ratio, and a history of increasing dividends. A high yield is great, but only if the company can afford to maintain it.
How to build wealth with dividends
An investment of £10,000, in a portfolio yielding 7%, would generate £700 in annual dividends. Reinvesting these payouts means the portfolio would grow modestly and could double in just over 10 years.
With the contribution of a further £3,000 per year to that portfolio, it could soar beyond £70k in 10 years. In 20 years, it could be over £200k, paying dividends of £7,500 per year.
That’s the power of compounding — turning today’s dividends into tomorrow’s wealth.
Stock picking
Achieving a portfolio yielding 7% requires very careful stock picking. Long-term dividend investors tend to avoid popular, trending stocks and opt for safe, boring companies.
Gas and electricity supplier National Grid (LSE: NG.) could fit the bill. It’s often cited as one of the best UK dividend stocks and is frequently found in passive income portfolios. The shares enjoy moderately stable growth, up 108% in the past decade. But more importantly, it pays a reliable dividend with a 5.8% yield.
Recently, it’s faced the risk of losses in its efforts to meet energy transition goals. This has been compounded by higher labour expenses as a result of the new UK Budget. If expenses get too high, it may have to cut its dividend to save capital for daily operations.
As a highly-established and critical utility provider, it’s likely to remain in high demand for decades to come. It also exhibits defensive qualities, typically performing well even through economic downturns.
There are many similar UK stocks with high yields and steady dividend growth on the FTSE 100. Some examples include Legal & General, British American Tobacco, and Tritax Big Box REIT.
By reinvesting dividends now and staying patient, I’m building towards a future where my investments pay me instead of the other way around. The road to financial freedom starts with smart choices today.
