There are numerous ways to generate a passive income. But dividends from stocks are arguably one of the easiest. After all, it doesn’t take much capital to get the ball rolling. And by reinvesting any income received in the short term, the wealth-compounding process can be greatly amplified. So much so that an initial £5,000 lump sum can eventually turn into a £1,340 passive income stream. Here’s how.
Investing in income shares
Looking at the FTSE 100, British investors, on average, earn a 4% yield through dividends and a further 4% through capital gains. And by snapping up shares in something as simple as an index fund, it’s possible to replicate these returns instantly.
At 4%, the passive income generated by a £5,000 investment would equate to roughly £200 a year. While having this extra cash at the end of each year certainly wouldn’t hurt, it’s not exactly a life-changing sum. That’s where stock picking enters the picture.
Instead of opting for an index investing strategy, investors can take a more hands-on approach to their portfolio. By selecting the specific companies they want to own, it’s possible to lock in a significantly higher dividend yield. That’s especially true in 2024, with many FTSE shares still recovering from the recent correction, resulting in higher payouts.
Suppose the yield was boosted by another 2% to 6%? In this case, my passive income stream would instantly grow to £300 a year. An extra £100 may not seem like much. But when compounded over decades, it can add up considerably.
By reinvesting dividends and pairing them with 4% capital gains, a £5,000 initial investment could grow to £268,500 in 40 years with no further capital injections. That’s the equivalent of a £16,110 passive income, or £1,342.50 a month.
A 6%-yielding dividend stock to buy now?
This income calculation comes baked with a lot of assumptions. As recent history has demonstrated, the stock market occasionally decides to throw a tantrum that can disrupt a portfolio. In other words, investors may end up with less than expected four decades from now.
There’s also the challenge of finding income stocks capable of paying, maintaining, and growing a 6% yield. A quick glance at the FTSE 100 reveals plenty of viable candidates, with popular names like Lloyds coming close to this threshold. However, personally, I’m more interested in businesses with a proven track record of raising shareholder payouts, even if the yield is initially below target.
That’s why Safestore Holdings (LSE:SAFE) could be a good fit to consider for an income portfolio. The self-storage provider has continuously hiked dividends every year for 14 years at an average annualised rate of 18%! Considering demand for such services isn’t likely to disappear any time soon, this upward trend could continue for many years to come. That’s especially true, considering the group’s international expansion is opening the door to plenty of new opportunities.
Of course, as with any investment, there are still risks to consider. Owning and operating a real estate empire doesn’t come cheap. And the company has racked up some considerable debt along the way.
Safestore’s current leverage looks sustainable. However, a prolonged downturn in this cyclical market could change that. Nevertheless, if I were looking to build a high-yield passive income portfolio today, Safestore would definitely be part of it.
This post was originally published on Motley Fool
