I’ve been buying dividend shares recently for my investment portfolio. In doing so, I’m looking to make investments that can generate cash for me for the long term.
By buying stocks and reinvesting the dividends, I can increase my passive income over time. With the right investments, I think earning £900 a year from a £5,000 investment is realistic.
Turning £5,000 into £900 a year
Turning £5,000 into an investment that can yields £900 per year takes time. Exactly how much time depends on what kind of return I can generate.
On average, the FTSE 100 has returned just under 7% per year for the last two decades. There’s no guarantee this will continue, but I think a 6% annual return should be achievable.
At that rate, a £5,000 investment would generate £900 per year within 20 years. And there are a couple of strategies that I could use to aim for that target.
Dividend growth investing
One approach involves buying shares that don’t offer a 6% dividend today, but have a decent chance of doing so in the future. Unilever is one example.
At today’s prices, Unilever shares come with a dividend yield of around 4%. But the firm is one of the most consistent FTSE 100 stocks when it comes to increasing its dividend each year.
If the business can grow its dividend at an average of 4% per year, it will generate an average annual return of 6% per year. This looks like a realistic possibility to me.
This approach is risky – the growth needs to materialise or the investment won’t work. And it’s not like demand for the everyday essentials the company sells is likely to surge any time soon.
Despite this, Unilever has grown its dividend at over 5% for the last decade. This makes me optimistic that it can achieve the required 4% going forward.
High-yield stocks
The other strategy involves investing in stocks that already offer a 6% dividend today. And there are plenty to choose from, including NatWest Group, which currently comes with a 7.5% yield.
In this situation, I’ll reach my target as long as the dividend doesn’t go down significantly. It’s probably worth noting, though, that the market seems to think it will.
There’s a definite risk of this happening. For one thing, rising interest rates might well cause an increase in loan defaults, which would be bad for the firm’s profitability.
With investing, though, it’s important to think long term. The near future might be challenging for NatWest, but the question is how it can perform on average over the next 20 years.
The UK government looking to divest its stake in the business could mark a turning point for the bank. I wouldn’t be surprised if it turns into a reliable passive income source going forward.
Either/or?
There are a couple of ways to try and achieve a 6% annual return. One involves buying shares that can grow their dividends and the other focuses on stocks with high yields right now.
There is, of course, absolutely nothing to say investors can’t do both, though. And I think a balanced approach gives the best chance of turning £5,000 into a stock portfolio paying £900 a year within 20 years.
The post Here’s how I’d use dividend shares to try and turn £5,000 of savings into passive income of £900 a year appeared first on The Motley Fool UK.
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Stephen Wright has positions in Unilever Plc. The Motley Fool UK has recommended Unilever Plc. 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.
