- Dividend income could be a better alternative to interest income in a falling interest rate environment.
- Dividend payout is highly dependent on the earnings of a company coupled with its uncertainty of dividend policy.
- Before making a dividend portfolio, an investor needs to look for a targeted yield, based on his financial goals.
Getting an extra income in the form of dividend on a long-term stock is not a bad idea. Especially during the times when interest rates are falling, dividend income could be a better option than the interest income on bonds.
The good part of this form of passive income is all the hard work that goes into selecting the right stocks for the portfolio is done only once, whereas the benefits could be reaped for decades.
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Most of the times, an investor has a fixed goal in mind as to how much dividend income he wants to scale up to in the future, that enables him to chart the course of action towards that trajectory. This could include planning for monthly investments, a judicious mix of high-yield and low-yield stocks to manage the risk at the portfolio level, etc.
Before diving into how an investor can plan for AU$3,000 a month of dividend income, one thing needs to be clear that there is no one right way to make a portfolio for dividend income. There are numerous variables that go into chalking out a plan for dividend income which varies from investor to investor. On that note, let’s have a look at how one can create a portfolio to get AU$3,000 a month of dividend income.
Read More: Five dividend stocks with yields above 10%
- Target an average dividend per dollar of investment
Selecting a good dividend paying company is very crucial and before doing so, one needs to be clear on how much dividend per dollar of investment he is aiming for. The dividend you receive on AU$1 of investment will ultimately decide how much money you need to put in to rake in the desired dividend amount.
To make it simpler, an investor can look at the dividend yield ratio that simply compares the dividend paid with the share price of the company. The dividend per individual scrip may vary and average yield could be maintained at a portfolio level.
Let’s say, investor B is looking for a dividend yield of around 10% for his dividend income portfolio. He may start looking for stocks that generate a dividend yield of about 10%.
- Pay heed to the quality of dividends
The quality or the sustainability of dividends is probably more important than the dividend itself. A company that has payed a healthy dividend in the past couple of years but has no history of dividends before that could be a risky bet as the future trajectory is difficult to judge.
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Also, one-time special dividends can help shoot up the dividend yield, which also needs to be accounted for as these dividends are once-in-a-while payout. Other key checks such as financial health of the company, management quality, competitive advantage also help in separating the wheat from the chaff.
Coming back to investor B, he may ignore small-cap companies to minimise his risks and look for well-established businesses. Hence, he might select Fortescue Metals Group Limited (ASX:FMG), which is the fourth largest iron ore producer in the world, trading at a yield of 10.9% (as of 9 June 2021).
- Gauge the amount of investment
After filtering out the quality of stocks based on the targeted dividend yield, an investor can easily calculate the amount of money he needs to invest to garner that passive income. For example, if a company’s share price is trading at a dividend yield of 5%, then on an investment of AU$100 an investor can expect a dividend of AU$5. This helps the investor to get an approximate idea for the amount of investment needed for the desired dividend income.
Now, investor B may simply calculate the amount required for a dividend income of AU$3,000 a month. The current share price of FMG is AU$22.65, that translates to a dividend income of AU$2.46 per share per year. Trimming it down to the monthly income, it stands at AU$0.205 (AU$2.46/12) per month per share.
So, by now it is clear that an investment of AU$22.65 would fetch a dividend of AU$0.205 per month. So how much would investor B need to invest to amplify it to AU$3000 a month income? Approximately a sum of AU$331,436 or 14,634 FMG shares would be required.
This method is used for one stock and the same can be applied for other stocks as well. It is always better to have multiple stocks in the portfolio to mitigate the risk of any one stock.
- Keep tracking the portfolio
Despite laying out an entire course of action, an investor needs to accept the fact that financial markets are ever-changing. Dividend payout is highly dependent on the earnings of a company as well as its dividend policy. The management can make amendments in the dividend policy any time to increase or decrease the dividend payouts.
Also, the earnings of a company never remain constant. There is a plethora of uncountable factors that directly or indirectly affect the earnings. If a company’s earnings are looking good today, there is no guarantee that it might not go to the dogs tomorrow.
The share price also fluctuates within seconds which affects the dividend yield. A stock going down in price could fetch a higher yield despite the actual dividend being constant and could be utilised for dollar cost averaging if that stock is already in the portfolio.
If FMG share price falls in the future (as the price keeps on fluctuating), investor B can add more FMG shares to his portfolio at a higher yield.
Read More: Three ASX shares for dividend income