Building a reliable passive income stream might seem like a daunting task, especially if I don’t have loads of spare cash lying around. However, in the stock market, even small initial sums can snowball into substantial wealth over time.
For example, the FTSE 100 has generated a 6.9% annualised return over the last 20 years. If I’d invested £500 back then and reinvested the returns along with just an additional £20 contribution per month, my initial investment would be worth £12,000 today.
One of the most effective strategies to achieve this kind of growth is by harnessing the power of dividend shares and compounding their returns over time. I’m going to take a look at the steps I would take to start generating cash using this method with as little as £500.
The power of dividend shares
Out of the numerous investment options available, high-yielding dividend stocks stand out when trying to build passive income. Many established UK companies have generous dividend policies: the FTSE 100 average yield is around 4% to be exact. These dividends grant investors access to a portion of the company’s profits and can quickly fuel a significant passive income stream.
Sure, savings accounts might offer similar yields, but stocks offer something that savings accounts don’t: the potential for growth. This potential does come with risks, as dividends could be reduced, and stock prices often fall before they rise. However, in my opinion, the potential for returns far outweighs these risks.
Picking the right stocks to compound interest
There are currently over 2,000 companies listed on the London Stock Exchange, but not all of them pay a dividend. Not only do I need to pick a stock that pays a dividend, but I want to choose one that has a stable history of paying investors. Past dividend payments are no indication of future returns. However, a strong track record of payments usually indicates some stability in the profitability of that company.
There are 58 stocks within the FTSE 350 that have consistently increased dividends for at least a decade. These are the companies I would start with.
To mitigate risk, I would split my £500 between two or three businesses. Even with a small investment, diversification can significantly reduce portfolio risk.
In order to maximise my returns, I would reinvest my dividends after they’re paid to me. This reinvestment would allow me to buy more shares, in turn generating more dividends. This is known as compounding and it can be a powerful tool. This snowball effect can build my initial £500 investment into a substantial passive income stream over the long term.
The bottom line
In conclusion, generating a passive income portfolio with as little as £500 is not only possible but also very realistic. To start generating cash today, I’d focus on high-dividend stocks with a history of consistent payouts. By reinvesting the dividends I earn on these stocks, I can continue to grow my passive income stream for years to come.
The post How to start generating passive income with as little as £500 appeared first on The Motley Fool UK.
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Dylan Hood has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
