Generating a passive income from dividend shares to replace my monthly salary sounds a bit fanciful. After all, the ongoing stock market correction perfectly highlights the risks of holding stocks, even the large-caps.
While rising interest rates do make savings accounts a bit more attractive, they still pale in comparison with the yields of high-quality dividend-paying stocks. And with all the chaos circulating the UK bond market right now, buying equities remains the best income-building strategy, in my mind, even with the heightened volatility.
So if I wanted to generate a salary-sized income in the stock market, how would I do it?
Building a resilient income with dividend shares
The biggest priority for any source of income (beyond its size) is reliability. Investing in stocks that pay a handsome dividend today is worthless if the payouts will stop tomorrow. That’s why accessing a company’s ability to provide a steady income stream is paramount before becoming a shareholder.
Fortunately, assessing the affordability of dividends is relatively straightforward. I can just compare the total amount paid with the group’s net income – both of which can be found on the cash flow statement. Suppose payouts are easily covered by earnings? In that case, it suggests the business can maintain my stream of passive income even if short-term disruptions cause sales to suffer.
Beyond offering a lucrative income today, I want to invest in dividend shares that can grow their payouts over time. Over the long term, a business capable of continuously increasing its dividends can profoundly impact my wealth.
Case and point, Coca-Cola has increased its dividends for more than 60 consecutive years. As such, Warren Buffett’s original investment back in 1988 now generates a 52% annualised yield!
Diversifying the income stream
As tempting as it may seem to find and buy the best dividend shares today, it’s worth remembering the importance of industry diversification. Some sectors are highly cyclical and can experience prolonged challenging periods during which dividend growth could grind to a halt.
We’ve already started seeing signs of this in 2022. With the cost-of-living crisis sending consumer spending down the toilet, the cash flow of many businesses is beginning to feel the pressure, including industry titans. And for some, dividends have been cut, or suspended, to maintain financial health.
Don’t forget dividends are paid at the discretion of management from a pool of excess earnings. And if those funds dry up, shareholder payouts usually follow. Therefore, it’s critical to diversify across multiple high-quality enterprises. That way, if one should falter, the others can mitigate the impact and keep the money flowing into my bank account.
Replacing my salary with dividend shares isn’t going to happen overnight. But, given time, compounding can do its magic. And with a large enough nest egg, even a 4% portfolio yield can be enough to substitute my earnings.