Income stocks are an excellent source of passive income. They require very little effort or oversight on my part, except for picking them.
The dividend is by no means guaranteed, but many income stocks will look to ensure their investors are rewarded for their investment.
I’m using income stocks to create wealth for the long run, let’s say 30 years. If I’m lucky and execute my strategy well, this could mean I can retire early.
I use a process called compounding returns or compounding interest.
This strategy can help my portfolio grow without having too much exposure to growth stocks, which are inherently riskier.
The maths
Compounding works by reinvesting dividends back into the stock market.
Let’s take a company offering 5% dividends. It’s unlikely to remain constant for 30 years, but let’s assume that its average dividend yield across the period is 5%.
If I invested £10,000 today in this stock, and reinvested my dividend payments, in 30 years my investment would be worth £44,600.
But let’s assume that every year for the next 30, I’m going to invest £10,000. This is where the maths gets tricky.
For a 29-year investment, I could expect £42,500, for 28 years, £40,400 etc.
At the end of the process, I’d have around £711,000 from what would be a £300,000 investment over the course of 30 years.
If I were lucky enough to put away £20,000 a year using the same calculation. My £600,000 investment over 30 years would be worth £1.4m.
It’s also worth remembering that these figures discount any organic upward movement in the share price.
Both of those figures would help me retire early.
The stocks
Big dividends aren’t always sustainable. As such, if I want to pick stocks that are going to be paying dividends over a 30-year period, I won’t be choosing stocks paying 10% dividend yields right now.
So, I’d look at stocks including Lloyds, Legal & General and Hargreaves Lansdown.
Lloyds is a FTSE 100 stalwart. The banking stock is heavily focused on the mortgage lending market. Loans for property account for 71% of its lending.
The stock is currently offering an attractive 4.75% dividend yield. This is also sustainable. Last year the bank had a dividend coverage ratio of 3.75. That’s very healthy.
Legal & General are offering a sizeable 7.5% yield, after a stellar 2021. It’s an unpopular investment for many, but it’s also a massive player in the asset management business. The brand is well known and this should help it attract customers and reduce net investor outflows in the future.
Hargreaves is currently offering a 4.7% yield and in the long run, I see the share price moving upwards. It’s investment platform is well positioned to benefit from investor trends.
I could also looking at housing stocks. Now might be a good time to buy too as higher rates push housing stocks lower.
Of course, all of my stock choices come with their own risks that are both specific to the company concerned and to the sector they operate in. But I still feel they’re good choices for my long-term future.
I would certainly avoid stocks in tobacco. Regulatory changes could massively damage these firms over the long run.