I reckon investing in dividend shares is a fantastic way to build a passive income stream. In an ideal world, I’d like to enjoy this additional income later in life, when my expenses are lower, and my kids aren’t relying on me anymore.
Let me break down some numbers and some steps I’d follow.
The plan
The first thing I need to do is choose my investment vehicle of choice. This is to ensure I maximise my pot of money. For me, a Stocks and Shares ISA is a no-brainer, for two reasons. One is the favourable tax implications of dividends while using this method, and the other is the generous £20K annual allowance.
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Next, I need to ensure I’m picking and buying the best stocks to receive the most dividends possible. I’d look for Dividend Aristocrats, but also bear in mind that the past isn’t a guarantee of the future. Other aspects I’d consider include reviewing performance, a firm’s balance sheet, and future outlook.
Now let’s crunch some numbers. If I wanted to bag a five-figure additional income stream through dividend investing, I’d love to be able to start with a lump sum. Let’s say I have £10K to kick things off.
Next, I’d put some money in each month from my wages — I’ll say £200 per month. I’m going to follow this plan for 20 years, and aim for an 8% rate of return.
After 20 years, I’d be left with £167,072. For me to enjoy this, I’d draw down 6% annually, which equates to just over £10,000 per year.
It would be remiss of me not to mention some potential pitfalls. The biggest issue is that dividends are never guaranteed. Next, all stocks come with individual risks that could dent earnings and returns. Finally, if I earn less than my projected return, I’d be left with less money to draw down from.
Which stocks should I buy?
If I was following this plan today, Aviva (LSE: AV.) is the type of stock I’d love to buy. The multi-line insurance business ticks a lot of the boxes I look for when buying stocks.
Firstly, a generous dividend yield of over 7% is attractive. For further context, the FTSE 100 average is closer to 3.6%.
Next, the shares look good value for money on a price-to-earnings growth (PEG) ratio of 0.5. Any reading below one can indicate value for money.
Moving on, the firm possesses excellent brand power, and a good track record, too. Furthermore, many of its products, including life and car insurance, are the type of products that I see rising in demand. This could help grow earnings and returns for years to come.
However, the bear case is that economic turbulence could hamper performance and investor payouts. For example, during trickier times, consumers may put less of a priority on buying non-essential policies such as life insurance as they deal with higher costs of living. A smaller concern of mine is the intense competition in the sector too.
