I am aiming to build a passive income stream of around £1,000 a month. One asset I plan to focus on to achieve this aim is dividend shares. Indeed, I believe buying dividend shares is one of the most straightforward ways of achieving a regular income.
That said, as dividend income is paid out of company profits, it should never be taken for granted. If a company’s profits suddenly decline, the business may have to reduce its distributions to investors. Shareholders are usually the first to suffer if a corporation sees a sudden drop in profitability.
However, despite this drawback, I believe the strategy still has tremendous potential.
Passive income strategy
To earn a passive income of £1,000 a month, I estimate I will need to build a large financial nest egg in the first place. I believe I can buy a portfolio of stocks and shares with an average dividend yield of 5%. If I invest around £300,000, I estimate I could earn a passive income of approximately £13,000 a year at this rate of return.
There is a bit more to my strategy than just buying stocks yielding 5%. I am targeting companies at both ends of the income spectrum. Enterprises that offer dividend yields of more than 5%, and less than 5%. I believe this style will help me build diversification into the portfolio and reduce the impact of any dividend cut on my income stream.
Some examples of the organisations I will be buying for my portfolio include Phoenix Group, which currently supports a dividend yield of 7%. Over the past couple of years, this company has proven itself as a dividend champion. It manages a portfolio of pension and life insurance assets to generate cash to return to investors.
Another company I would buy at the other end of the yield spectrum is the generic pharmaceuticals business Hikma. With a yield of less than 2%, this stock is not a traditional income investment. Nevertheless, with profits set to rise substantially over the next few years, I reckon there is plenty of room for the payout to expand further in the years ahead.
While I would buy both of these stocks today for passive income, I should note they are not immune to the risks I have outlined above. If either firm suffers a fall in profits, they may decide to slash their investor payouts.
Dividend shares for the long run
That is the strategy I plan to use to generate a passive income of £1,000 a month. Unlike other income strategies, this approach does not require a lot of work. All I need to do is select a portfolio of stocks, and then I can sit back and let these companies take care of themselves.
That is another reason why I have decided to follow this approach.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has recommended Hikma Pharmaceuticals. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.