On the face of it, making £10,000 a year from passive income might seem far-fetched. It’s a significant amount of money that could enable me to spend more time doing the things I enjoy doing. I’m not going to claim that I can make this kind of money overnight from dividend shares. But over the period of several years, I think that it’s achievable to benefit from dividend payments to the tune of five-figures per year. Here’s how I’m planning on doing it.
Thinking through the basics for passive income
Firstly, I need to understand where the passive income is coming from. My aim is to use dividend payments to generate the money for me. So I need to invest in sustainable stocks that can offer me such payments going forward.
The main way I differentiate between dividend stocks is by looking at the dividend yield. This highlights the dividend per share relative to the current share price. Ideally, I want a high yield.
At the moment the average FTSE 100 dividend yield is 3.76%. So from this I can gather that if I invested £100,000 now, my annual passive income would be £3,760. This seems a long way from my £10,000 aim, but hear me out.
Firstly, I can select dividend stocks with above-average yields. Examples include Imperial Brands with a yield of 9%, or Legal & General Group with a 7% yield. By investing in a selection of these companies, I think I can get an average yield of 7.5%.
Secondly, I don’t have to hit £10,000 straight away. Rather, I can invest smaller amounts of money and reinvest the dividends over time. After all, this is a long-term play, not something for next month.
Putting the numbers together
From my calculations, I can start by investing £500 a month. I’d invest in a portfolio of dividend shares with an average yield of 7.5%. The passive income I receive over the months I’d reinvest straight away. This helps to build my pot up faster over time. With these numbers, after 13 years, I would have a pot size of about £133,000. Then in year 14, I would be able to receive around £10,000 in passive income.
I can tweak the numbers depending on my situation over time. For example, I could look to vary the amount I invest each month. Due to the time scale, increasing my amount by only a small amount can speed things up a fair bit. If I invested £600 a month instead, I’d reach my goal almost 18 months in advance.
There are some risks to my plan. One major one is the assumption of having steady dividend payments over such a long period. As the pandemic has shown, companies can cut dividends quickly and without much notice. Another risk is that I might need cash flow during this period, or even have to pull some money out. This would cause my future projections to be thrown off.