A step-by-step guide for some things is invaluable. And when it comes to me trying to make four-figures a month in passive income from dividend stocks, having a breakdown can help me to avoid mistakes. Even though I’ve not hit this goal yet, I’m on my way. Here’s how I’m doing it.
Gauging timeframes and amounts
Before it comes to specific dividend stocks, I first want to gauge a realistic timeframe. When do I want to be able to start enjoying the income? I’m trying to ensure that this comes before retirement age and ideally, I want it to be as soon as possible. But I acknowledge that realistically it’s going to take several years, if not longer.
By figuring this out to begin with, I have a clear target to aim for.
After this, I need to decide how much I can afford to invest in stocks. This ties in with my first point on timings. If I can only afford to invest £100 a month, I might be at risk of not being able to reach my goal in time. Conversely, if I can park a large amount of money upfront into some solid companies, I could reach my goal early.
Once I’ve figured out the amount, I’d try and split it up in monthly instalments. This helps me in a few ways. The obvious one is that it makes my cash flow situation better, rather than turning out a huge amount once a year. Also, investing each month helps me to benefit from more frequent compounding, instead of on an annual basis.
Picking the right shares for passive income
My fourth step is to pick specific shares. I need to be careful here that I don’t buy a stock just based on the dividend yield.
For example, let’s say I’m going to invest £400 a month and want to reach my goal of earning £1,000 a month in passive income in 15 years or less. To do this, I’d need to target an average dividend yield above 8%. This is possible, but would mean I’d have to buy some risky stocks due to the high yield needed.
Instead, I’d prefer to filter for stocks with a yield between 4% and 8% and select the ones that I think are sound firms with good future potential for income. If this means it takes an extra year or two, or means I’ll need to increase the money to £450 a month, I’d prefer to do it that way.
Time to go
My final step is to put this all together and get going. My sweet spot is £425 a month with an average 6% yield, taking me pretty much 20 years to reach my goal. This timeframe works for me, given my current age and working life aspirations, but I have to accept that things can go wrong and I might not reach my goal.
Even when things are going right, the work isn’t finished. I need to monitor the stocks I pick, as the risk is that dividends get cut in coming years. I also need to be careful about reinvesting my dividends in the right places. Finally, I have to be careful about future changes to my personal income, as this could inhibit my ability to invest for a period of time.