Dividend shares have many desirable traits for investors. They typically act as a source of stability within a portfolio, providing a solid foundation for a nest egg. But more excitingly, these firms provide a secondary passive income stream. And with enough capital, it’s possible to generate life-changing sums with next to no effort compared to buying rental property or starting a business.
With that in mind, let’s explore the steps investors can take to generate up to £10,000 a year or more.
Setting a goal
Everyone has different investing objectives in life. And that makes investing a highly personal endeavour. But let’s assume £10,000 is the ultimate objective. How much money needs to be invested into dividend shares to start earning this sum?
This ultimately depends on the yield a portfolio can generate. Throughout its existence, the FTSE 100 has offered a payout of around 4%. And if an investor were to match this with a simple low-cost index fund, a portfolio would need to be worth around £250,000.
Obviously, for most people, that’s not pocket change. But there are a few tactics which make achieving this target far more realistic than it might seem at first, even starting from scratch.
Compounding the way to wealth
There are two primary sources of returns in the stock market. Dividends are one. Share price appreciation is the other. It just so happens that the FTSE 100 has also provided a further 4% in annual capital gains throughout its lifetime, bringing the total average return to 8%.
At this rate, investing £500 a month for just over 18 years will grow a portfolio to the £250,000 threshold when starting from scratch. While it’s undoubtedly quite a long wait, the extra supplementary income could be a game-changer for many households. It could be the key difference which makes more holidays and new experiences affordable for partners and children alike.
However, even if a household is unable to comfortably spare more than £500 a month, there are ways to accelerate this timeline. By picking individual dividend shares, it’s possible to design a portfolio that provides a higher yield. Even achieving just an extra 1% payout is enough to bring down the portfolio size threshold to £200,000. And combining this 5% yield with the same 4% capital gains means the compounding process would wipe out just under four years from the waiting time!
A word of warning
As exciting as earning an extra £10,000 sounds, investing, sadly, never provides any guarantees. Historical performance rarely serves as a solid indicator of future returns. As such, an index-tracked or custom-tailored portfolio may deliver lower gains than expected. In fact, they could end up destroying wealth rather than creating it.
Eighteen years is plenty of time for another crash or correction to flip the table and send a portfolio tumbling. These situations do provide excellent buying opportunities for long-term wealth building. But it also means investors could be waiting far longer than expected before earning their passive income target.
Nevertheless, investing has proven to be one of the best ways to grow wealth over the last 200+ years. And that’s not something I expect to change anytime soon. In other words, the risk is worth the potential reward, in my opinion.
The post How to target a £10k passive income using dividend shares appeared first on The Motley Fool UK.
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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.
