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I reckon it’s entirely possible to create a passive income stream by buying dividend stocks, and letting compounding work its magic. Let me explain how I’d approach this challenge.
Kicking things off
Firstly, I’d open a Stocks and Shares ISA due to the favourable tax implications on dividends received. I’m going to need this due to dividends being the bedrock of building my pot of money.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Next, I need to pick the best stocks to help me bag returns. I’m going to diversify my holdings to mitigate risk. More crucially, I’ll ensure I look for the most consistent returns from blue-chip names I understand and can get to grips with.
Crunching some numbers, let’s say I have £10K to get the ball rolling towards a healthy pot at the end. I also want to add to this regularly to maximise my end sum of money, so I will commit £250 per month from my wages.
Using all this, in my ISA, invested into the best dividend shares, and aiming for a return of 8%, would leave me with £311,158 after 25 years.
Finally, I’d draw down 6% annually, leaving me with £18,669 to spend how I like.
Risks I’m wary of
The first issue is a biggie, which is that dividends are never guaranteed. They can be cut or cancelled to conserve cash.
Next, each individual stock comes with its own risks I must carefully assess and be aware of. This is because performance and returns could be impacted.
Finally, although I’m aiming for an 8% rate of return, I could end up with less if the stocks I buy yield less. This would leave me with less in my pot to draw down from and enjoy. Conversely, I could yield more and earn more.
Stock picking
If I was following this plan today, I’d buy ITV (LSE: ITV) shares for juicy returns.
Now you might be wondering how a legacy television broadcasting business could be a good pick for returns for years to come. Yes, I’m aware of the threat of streaming giants grabbing market share as the way consumers watch content has changed. Plus, I do understand that advertising spend is under pressure, and this is one of the main money spinners for firms like ITV. I’m aware of these ongoing risks.
However, there’s lots to like about ITV, in my view. To start with, its own streaming platform, ITVX, is growing in popularity, after extensive investment from the business.
More crucially, the firm’s production arm, ITV Studios, is hugely popular and has churned out many successful hits such as Love Island and I’m a Celebrity. If it can continue in this vein, both of these aspects could catapult ITV’s performance to new heights, and offer generous returns in the future.
Finally, once economic volatility dissipates, advertising revenue could rise once more, boosting the firm’s bottom line.
Moving over to fundamentals, ITV shares offer an enticing dividend yield of over 6%. Furthermore, the shares look fantastic value for money right now on a price-to-earnings ratio of close to eight.
