Image source: Getty Images
Many investors find it appealing to have a goal of making passive income. The exact amount varies depending on several factors, including how much someone can afford to put in the stock market each month. Yet, if a disciplined approach is taken, the income can increase over time, especially if good dividend stocks are purchased.
Some of the factors at play
I’m going to assume that £500 a month is the amount that can be invested in dividend stocks. Of course, this will vary from investor to investor, but we have to start somewhere. The next factor to look at is the yield that the portfolio could offer each year.
As a benchmark, the average yield of the FTSE 100 is 3.27%. So if an investor bought a tracker index that paid out the dividends, this would be the yield. But there are stocks in the index with a yield above 8%. So with active stock picking, it could be possible to target a yield between 5% and 7%. If I included the FTSE 250, it could be possible to target a yield closer to 10%, but this would be quite high risk. I’m not sure how sustainable that level of income would be.
Another factor is the timing involved. If initial dividends can be reinvested back into the portfolio, future passive income potential rises. This is because the money can compound at a faster rate. So if an investor is happy to wait for a decade before starting to spend the income, it could result in higher income than if it were being paid after just a year or two.
A share to consider
One dividend stock that could be included in a portfolio that’s pursuing this strategy is TP ICAP Group (LSE:TCAP). The financial broker connects institutions that wish to trade different assets like stocks and bonds, taking a small fee on each trade booked. It used to make most of its money through such trading, but has recently been trying to diversify revenue via providing data and analytics to clients as well.
Over the past year, the stock is up 14%, with a current dividend yield of 6.03%. I think the dividend is sustainable going forward. It has a clear dividend policy, targeting a payout ratio of about 50% of adjusted post-tax earnings. That means the company retains enough earnings for reinvestment and paying debt interest, while also distributing half to shareholders.
The company benefits from strong cash flow given the nature of its operations. This is beneficial as it provides more cushion to pay dividends and also means there’s not a large pressure to take on a lot of debt. If the company maintains this, I don’t see pressure on the dividend in the near term.
Of course, there’s some concern that TP ICAP need to keep adapting to survive. Trading is becoming more electronic and automated. Therefore, the need for brokers is diminishing. The business is diversifying, but it needs to ensure it keeps innovating, otherwise it could struggle.
The numbers
A portfolio with an average yield of 6% and £500 a month of inflows could stack up over time. In theory, after a decade it could generate £4,620 in the following year, just from dividends. This translates to £385 a month.
