The idea of making passive income from dividend stocks is one that has been very popular in recent times. It taps into my desire to make my money work harder, especially with years of very low interest rates. Even though the idea is simple, there are a few points that aren’t immediately apparent or clear. So before getting started, here are a few of my top tips to understand.
Understanding the numbers
First up is the understanding of how a dividend yield works. It’s a percentage that reflects the dividend per share relative to the current share price. When I buy a stock, the share price gets fixed at that point in time. But the dividend per share will vary as time goes on. So if I see a company that has a very high yield (such as 10%), I do need to take it with a pinch of salt. I can’t guarantee passive income of 10% of whatever amount I invest.Â
Rather, I’d look for companies that have sustainable yields, or those that have grown the dividend payment over several years. Two good examples that I wrote about recently are Unilever and British American Tobacco.
A second point is to grasp that aside from the yield, what really matters is how much I can afford to invest. Finding a gem of a dividend stock is great, but if over the next year I’ll only have £100 of spare cash, the passive income won’t really make much of an impact. In this case, I might be better targeting high-growth stocks, that could offer me strong profits over time from share price appreciation.
Careful planning to receive passive income
Thirdly, I need to understand how the dividend payments work. Typically, the company will declare the intent to pay a specific dividend. Next, there will be an ex-dividend date. This means that I need to own shares in the business before this date passes in order for me to receive the dividend on the later payment date. I can’t simply buy a stock the day before the payment date and expect to receive the passive income.Â
This requires careful planning on my side. It also leads on to my fourth point — my passive income is unlikely to be flowing every week. Each stock I hold might pay a dividend annually, semi annually or quarterly. Therefore, if I want to receive a stream of income, I’m best off investing in a portfolio of multiple stocks. For example, if I own a dozen stocks, there’s a good chance that each month I’ll receive some form of payment.
Finally, I should be conscious that alongside the dividends, the share price moves everyday. This means that on top of the income, I could generate a profit or loss from my capital when I come to sell the stock. This makes it even more important to identify solid long-term shares that can help me not only enjoy dividends but also share price growth.