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Dividend stocks are a popular way for some investors to generate passive income. Owning the stock gives them the right to receive a cut of the company’s declared dividend. And this money can be reinvested back into the stock market, compounding the benefits. Here’s how the strategy could play out over time.
Putting the money to work
With £10k in savings, it provides a good initial pot of cash to put to work. To begin with, I’d look at what yield the investor is trying to target. After all, the £10k is likely only earning 2%-3% annual interest in a regular savings account. Therefore, the added risk of buying stocks (where the capital can fluctuate in value every day) must be offset by a higher reward.
The average dividend yield of the FTSE 100 is 2.99% so I don’t think it makes sense to invest in a tracker. Instead, an investor could actively pick a selection of stocks in the 6%-8% range. The potential income is high enough to warrant withdrawing funds from savings and investing them in the market.
The next factor is assessing how long it could take to reach the goal of £455 a month in dividends. If only the initial £10k were used and no further money were injected, it could take 30 years, with an average yield of 7%. That’s a long time! However, if an investor could supplement the lump sum with £250 each month, it could take just under 12 years.
Of course, there’s no guarantee on these timeframes. The hot income stock of today could struggle years down the line, cutting the dividend. That’s why it’s good to have a diversified portfolio, so at least if this does happen, the impact can be manageable.
Boosting dividend payments
Actively picking good dividend shares in the 6%-8% yield range needs some research. One example to consider that I’ve researched is Chesnara (LSE:CSN). It has a current dividend yield of 7.2%, with the share price up 30% in the last year.
The FTSE 250 company isn’t the most traditional insurance and pensions firm, as it focuses on buying and managing existing life insurance and pension policies. It earns fees from administering these policies and profits from managing the investments backing them.
Its CEO said in the interim results in August that it saw “cash generation up 26%, an increase in our solvency ratio and a further 3% increase in the interim dividend”. Further, in December, it got regulatory approval for the takeover of HSBC’s UK life insurance division. This has boosted investor sentiment already, but could help even further as more details about the extra £4bn of assets under administration and 454,000 policies come through.
Against this backdrop, the dividend per share has been rising for several consecutive years. I can see this continuing based on the momentum from last year. However, one risk is that the stock market underperforms this year, leading to volatility in the assets Chesnara manages. This could not only hurt earnings but also cause reputational damage for clients who have their money with the firm.
Overall though, I think it’s a good stock for investors to consider as part of an overall strategy.
