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Instead of working more hours each week, owning income stocks and collecting the dividends can be a way to build my income.
But how does that work in practice? I’ll put an example below where he’s targeting £500 of dividend income per month.
Set a target income
As an investor, I think setting a target can be helpful. That way, when I invest, I know what to expect and can design my investment strategy around that.
When you set a goal, you want to make sure it’s attainable. For example, if I only have £1,000 to invest, there’s no point in hoping to earn £10,000 a month. If I set a realistic, achievable goal, with resources, I can increase my wealth over time. If so, I may have a financial mechanism that will help me aim for higher amounts in the future.
£500 a month can add up to £6,000 a year. That’s a huge amount – and I think I’ll have to spend a lot less to try and get the profits from income stocks.
Understanding the dividend
Exactly how much to invest depends on the average dividend yield of the stock I buy.
That’s basically the annual dividend expressed as a percentage of the price I’m paying for the shares. So, for example, if I pay £100 for a share and get £3 a year in dividends, let’s say the yield is 3%.
At a 3% yield, I would need to invest £200,000 to hit my target. If the average yield is 5%, I should buy £120,000 worth of income shares. I hope I can achieve my target by spending £60,000 on average 10% stocks.
Hunting for a quality income share
So, should I buy high-yielding stocks regardless?
Absolutely not! Knowing the dividend helps me understand what I’m getting per share, but it tells me nothing about the underlying business. Dividends are never guaranteed, so if I invest in a business that isn’t profitable enough in the future, it may reduce or cancel the dividend.
Instead, I always look for a company in an industry that I expect to do well in the future. If the company has a competitive advantage, that can help it make a profit. Then I look at the stock price, I think it’s worth it. Only at that point did I consider the profit margin.
So, for example, my own share is a polymer maker. Victorx. I expect demand for polymers to be resilient and just because Victrex owns the patent can legally make certain products. The yield is 3.4%. I own other income stocks with higher yields, but I think the 3.4% yield is attractive from what I’ve seen of a quality company.
But no matter how much I love Victorix – or any other income shares – even a large company can face unexpected problems. So I invest in different companies to try to hit my monthly target. And first and foremost, remember that I’m hunting for quality businesses that I think have a bright future.