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The idea of generating a second income to help pay the bills every month is enticing, especially if it doesn’t involve all that much effort. One approach that arguably fits the bill is owning a bunch of dividend stocks.
But just how much would someone need to have stashed away in a Stocks and Shares ISA to generate, say, £1,000 in extra cash every month?
Let’s take a closer look.
The ultimate passive income strategy?
The beauty of a dividend stock is that, once purchased, an investor doesn’t need to watch it like a hawk. Yes, the share price will go up and down (hopefully the former) but nothing else actually needs to be done to qualify for receiving a portion of the profits distributed by that company. It’s about as passive as money-making gets!
Of course, there are risks involved. Would-be dividend investors must realise is that the lovely income stream they hope to build can never be guaranteed. Businesses can and do go through sticky times. These can force management to reduce or completely cancel dividends in an effort to keep the lights on.
One way of reducing the likelihood of this happening is to focus on owning stakes in companies that tend to make money in both good and bad times.
More on that in a second.
How would all this work in practice?
Let’s say a person was able to put aside £500 a month to invest and managed to compound that money at 7% through a combination of share price growth and reinvesting dividends. This sort of growth isn’t unreasonable based on the very long-term performance of stocks in general.
After 20 years, they’d have a pot of almost £250,000. Assuming their portfolio then has a dividend yield of around 5%, they’d receive the equivalent of £1,000 every month.
But which companies might be worth holding to make this idea a reality?
One option to ponder
For me, National Grid (LSE: NG) always springs to mind as a great defensive dividend stock to consider owning. Since we always need access to gas and electricity regardless of how the UK economy is faring, the FTSE 100 power infrastructure operator generates very consistent cash flows. Theoretically, this should mean that dividends keep rolling out to investors even if markets crash.
Looking ahead, the firm should also benefit from the green energy transition and potentially huge demand drivers.
It’s not a slam dunk option, though. National Grid’s profits depend on regulators staying friendly. Due to the heavy costs that come from maintaining infrastructure, there’s already a whopping amount of debt on its books too.
It’s also worth pointing out that the Grid’s shares yield only 3.9%. While still attractive, that’s clearly a bit lower than the 5% yield needed to generate that £1,000 in our example. However, the latter can be achieved by also holding other stocks that pay a little more, albeit in exchange for the investor probably taking on more risk. Several of our biggest companies currently yield way over 5%.
This wouldn’t only generate the desired monthly income. It would also ensure that our investor isn’t completely dependent on just one company for their passive income fix.
