Passive income can be a great way to help you generate extra cash flow, whether you’re running a side hustle or just trying to get a little extra dough each month, especially as inflation rages throughout the economy. Passive income can help you earn more during the good times and tide you over if you suddenly become unemployed, if you voluntarily take time away from work or if inflation keeps chipping away at your purchasing power.
With passive income you can have money coming in even as you pursue your primary job, or if you’re able to build up a solid stream of passive income, you might want to kick back a little. Either way, a passive income gives you extra security.
And if you’re worried about being able to save enough of your earnings to meet your retirement goals, building wealth through passive income is a strategy that might appeal to you, too.
What is passive income?
Income that requires little effort to maintain is passive income. It can be additional income from a rental property, the stock market, or a company that you are not actively involved in.
What Are Stock Dividends?
According to Investopedia, a stock dividend is a payment to shareholders made in shares rather than cash.
Stock dividends are an excellent source of passive income, as they’re not taxed until sold. Moreover, when they are set up well, dividends can supply a solid cash flow, which you can either reinvest or use to live off in retirement.
To calculate your potential income from stock dividends, you can use the handy (and detailed) calculator tool from MarketBeat.
Note that dividends can bring in anywhere between a 2% and 5% annual return. If you find that you could be looking at an ROI that suits your needs, the following are the best strategies for using stock dividends to boost your passive income.
If you’re in your 20s or 30s and have got time to work on building up a solid passive income (before you actually need to access it), the best thing you can do is employ the compounding strategy.
Basically, if you’re working with a generous timeline — 10, 20 years, or more — you can simply reinvest your dividends to buy more shares. This will result in you earning even more shares, so you’ll have the means to buy more stocks.
The great thing about the compounding strategy is that it allows you to outpace inflation. (Yes, despite what you may think, saving money can mean that you lose its value).
So, at the end of the day, by employing the compounding strategy when investing in stock dividends, you’re not just getting your money back. But, you’re actually making a profit, which is the basis of building a reliable passive income.
Another benefit of reinvestment is that you can begin with a low starting capital. That’s right, investing even as little as $1,000 per year will be enough to start building a passive income for your retirement.
Investing in High-Dividend-Yield Stocks
Compounding is the best strategy you can follow to create passive income for yourself. However, if you haven’t got the time to wait for decades until your income meets your requirements, you’ll be better off focusing on your current portfolio yield.
Essentially, by targeting high-yield options (and putting up with a decent amount of risk), you can create the same income as investing in typical stocks but with less money.
Of course, the best way to employ this strategy is not to put all your eggs in a single basket. Instead, try to set aside a portion of your capital for high-yield stock and invest the rest in traditional dividend shares.
ETFs & REITs
Does the idea of boosting your passive income with stock dividends appeal to you, but you don’t have the time to rely on compounding or the patience to manually choose individual stocks to invest in? (After all, diversifying your portfolio can be challenging for beginner investors. Moreover, it can be a time-consuming task.)
Fortunately, there are a couple of solutions that might work for you.
ETFs (exchange-traded funds) and REITs (real estate investment trusts) are excellent alternatives to traditional investing strategies.
Yes, they can come with high fees, which will somewhat limit your returns. Moreover, your dividend payouts can be variable, which is not what you want (especially if you’re trying to generate a passive income for your retirement years).
Nonetheless, considering that with ETFs and REITs, you won’t have as much work with your portfolio, nor will you have to make high-risk decisions, these can be a solid option for boosting your passive income.
If you decide to go this route, however, make sure that you focus on income safety, as that is what you’ll appreciate the most — especially if you want to live entirely off of passive income.
How Much Do You Need to Build Passive Income with Dividends?
If you’re considering enhancing your monthly income with stock dividends — without working a second job — the best thing you can do is settle on a minimum amount you can invest every month.
Generally, around $500 per month is a good start, especially if you can keep it up for 20 years, which adds up to approximately $400,000.
With this approach, you can expect to receive around $1,000 per month in payouts, which is not that bad.
However, if you want to make your monthly passive income more generous (and give yourself more financial security), try to raise your investments over time. Or keep your monthly payments the same, but try to keep it up for 30+ years.
It’s All About Dividend Growth
Stock dividends tend to grow over time, unlike the interest from bonds. That’s one of the main reasons why stocks should be a part of every investor’s portfolio. Furthermore, dividend growth has historically outpaced inflation. For those investors with a long timeline, this fact can be used to create a portfolio that is strictly for dividend-income living.
A smart strategy for people who are still saving for retirement is to use those dividends to buy more shares of stock in firms. That way, they will receive even more dividends and be able to buy even more shares.
For example, assume you bought 1,000 shares of a stock that traded for $100, for a total investment of $100,000. The stock has a 3% dividend yield, so you received $3 per share over the past year, which is $3,000 in dividends. You then take the dividends and buy more stock, so your total investment is $103,000. Assume the stock price doesn’t move much, but the company increases its dividend by 6% a year. In the second year, you will get a dividend yield of 3.18% on $103,000 for a dividend of about $3,275. However, that is a yield on cost of about 3.28%.
This dividend reinvestment strategy continues to increase the yield on cost over time. After ten years, the hypothetical portfolio from the previous paragraph will produce around $7,108 in dividends. After 20 years, you will receive more than $24,289 a year in dividends.