Passive income with dividends
When it comes to generating passive income, dividend stock investing is a great method.It's fairly easy to set up a dividend portfolio and the returns can come pretty quick. Which makes this very ideal for a passive income stream.
The only caveat is that you need to have a starting capital before you can start building your dividend portfolio.
1. what are dividends?
Dividends are payments made by a company to its shareholders. When a company generates profit, it can decide to return a part of that profit to its shareholders. That is in short what dividends are.But not all companies pay out dividends (especially when they are still young and growing). These non-dividend companies prefer to invest their profit in growing the business and make it better.
So, dividends are in fact a 'thank you for trusting us, and here is a little reward for that trust' from these companies.
Dividends give shareholders a direct return on their investment next to the potential capital gain of the stock itself.
2. Why invest in dividend stocks?
There are several advantages making dividend stocks very attractive for investors:Steady income stream
Dividend stocks give you a regular stream of income. You can choose to reinvest these or these dividends can be seen as a consistent source of income.
There is one disadvantage to dividend stocks. The company can decide to lower its dividends or even to entirely stop paying dividends to its shareholders.
Stability and reliability
Companies that have a long streak of paying dividends (dividend aristocrats and kings) are often very well-established and financially stable.
Unlike other stocks which can show high volatility, dividends stocks mostly show a slow but steady growth which makes them a stable and reliable portion of your stock portfolio.
Inflation hedge
Dividend payouts have the potential to outpace inflation which makes dividend stocks a perfect hedge against rising inflation.
3. what is compounding
Compounding is reinvesting the received dividends into stocks again. Let's say you receive every 3 months 30$ dividend. With these 30$, you buy 2 new stocks for 15$ a piece. In the next period, you'll get 31$ dividends, ....This is also called DRIP (Dividend Reinvestment Plan), so over time you collect more and more stocks which gives you more and more dividends.
And now we get to the 'snowball' effect. Like a snowball getting larger and larger when it rolls down from a hill, the accumulated dividends keep on growing and growing over time. In the first few years, you will no see a big increase but after 10-15 years, you will see a kind of exponential rise in the dividend payouts.
4. Can you live off dividends?
Living off dividends can be possible but it may not be suitable for everyone and individual circumstances vary.Let's do some calculations: imagine you have a portfolio worth 400.000$ and your dividend yield is 4.5%. This means you get 18.000$ paid every year, which means 1.500$ per month.
Is this enough to live from? It all depends on where you live and what your expenses are. But also keep in mind that you have to pay taxes on your dividends too. and it can always happen that a company decides to cut its dividend payouts.
You must have a big portfolio to be able to live out of your dividends. But it can be an important cornerstone in your passive income stream.
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