Building a dividend-producing passive income portfolio requires thought, time, and education. Today I’m sharing 5 tips for building a successful dividend passive income portfolio and how you can figure out the right strategy for you.
As I’ve written before, this idea came to me after my wife and I reviewed her 401k at the end of 2020. She had by accident generated a large sum of dividends without even trying. This was the same for me in my 401k as well and we generated $800 in dividends by accident in our trading account.
As 2020 was ending I took some time to look at our 401k balances. This was a good year for our investments, all things considered, but one thing surprised me. There was a line item for “dividends earned” and it was quite a large number. My wife’s 401k earned more dividends than what I made as a salary in my first year out of college! via Passive Investing with Dividends
I couldn’t help but wonder what would happen if I focused on building this income. Could I retire early and spend the rest of my life doing fun things? I think the answer is yes, but I needed to do some research and figure out a strategy forward.
Tip 1 — Research
Before you do anything, and I mean anything, you need to start from the very beginning. That beginning is educating yourself about this particular strategy. My first tip is to join the Reddit group r/Dividends. It’s a very good group with lots of great information for anyone to get started. I go there for the discussion on different stocks, how to set up a portfolio, how to track it, etc.
…you will need time for this to grow.
Besides, the book “Get Rich With Dividends” (affiliate link) is a must-read resource. This book clued me into how to screen for Dividends in my brokerage account and what to look for in the fundamentals of a stock.
Tip 2 — Start in a Retirement Account
I’m not a tax professional but what I do know is that generating dividends is a taxable event. If you hold a dividend-producing stock in a taxable account like a brokerage account, you will pay taxes on that income. The best thing to do to build up your passive income is to do it first in a qualified retirement account like a 401k or IRA. I chose an IRA because it allows me to hold individual stocks.
Make smart buys now and just reinvest the dividends…
I reinvest all my dividends at no fee in my IRA because I don’t need the income right this moment but in 9 years. This leads me to Tip #3, you will need time for this to grow.
Tip 3 — You Will Need Time
I spoke with a friend recently who’s taking care of his father. His father is very old but was smart in his younger years to amass a sizable stock portfolio. He kept reinvesting his dividends for over 5 decades! When my friend looked at the amount of money that was being reinvested and what the costs were to provide long-term care to his father, he stopped reinvesting the dividends. He just took the dividend payout as income to help his father now. What good would reinvesting the dividends be at this stage in his father’s life?
…fees and keeping your transaction costs low is the key to getting the most out of your passive income stream.
His father didn’t touch the stocks and dividends for 50+ years and was able to amass what sounds like a massive passive income stream. Sure it took 50+ years but that was what worked for him, not you. However, you will need time, which is why I’m working on a 9-year time horizon.
Make smart buys now and just reinvest the dividends so that when you reach the end of your time horizon, you will have hit your target.
Tip 4 — Pay Attention to the Fundamentals
If you read “Get Rich With Dividends” will quickly learn that the author has a specific method for analyzing a stock’s fundamentals. I think this is a solid approach and you should apply this logic but change it based on your risk profile.
For example, he suggests sticking with stocks that have dividend yields between 3 and 5%. I keep to that suggestion mostly but I do own some stocks that generate higher yields than that. Why? Because I can stomach the risk better.
The key fundamentals he looks out for are things like the Dividend Yield, Beta, Earnings Growth, and Payout Ratio. I like to also look at the PE Ratio so I can gauge how ‘frothy’ at stock is.
Tip 5 — Diversify
Ever since I read “A Random Walk Down Wall Street” I’ve been obsessed with diversification. This is why I add dividend-producing ETFs to my holdings. Yes, there’s a fee associated with holding an ETF and there’s a lot of discussion in r/Dividends and in the “Get Rich With Dividends” book about making your own portfolio to save money on the fees.
My thoughts on the matter are that I’m pushing my risk profile right now and the ETF can help spread that risk around. However, they’re 100% right, fees and keeping your transaction costs low is the key to getting the most out of your passive income stream. I will consider this when I start withdrawing mandatory distributions from my 401k and IRA.
The Ideas Are Endless
For example, I currently own QYLD because of the high dividend yield. It’s a small company that may or may not be around tomorrow. It’s risky for sure and I’m being a dividend slut. However, a company like $JNJ isn’t going away where. It will be around for years to come and if the price was to drop by 50% or more, it will likely continue to pay dividends that you can reinvest if you have a long enough time horizon. This way your average cost per share drops over time and your long-term risk drops.
There’s a lot to think about when adopting this type of strategy and it won’t work well for growth investors, but this works for me.
This got me thinking about a passive investing strategy that I first read about decades ago. That strategy was about dividend investing and how to build up a passive income strategy. It sounded cool, to have stocks, ETFs, or mutual funds generate $40,000 or $50,000 a year in dividend income! I figured it would be like having another person working for you and giving you their income! I could so easily live off that, I thought!
Companies like Coca-Cola and Exxon are very mature but not sexy like Tesla.
While this sounds great, there are some BIG caveats that made me skip this strategy. First, you need a large sum of money to buy shares in some stock, ETF, or mutual fund. If the assets depreciated, you could lose more than the dividend is worth. Also, dividends are taxable too.
Many times dividend producing stocks are mature companies. This means the days of rapid share price appreciation is over. Companies like Coca-Cola and Exxon are very mature but not sexy like Tesla. You wouldn’t be trend following Coca-Cola!
Still, there are companies out there that can do both. Apple is still growing and generating dividends, so those companies exist!
As I near an early retirement, I can’t help think that now is the time to build a dividend-generating portfolio! It makes sense to rebalance some money into those assets to build up a nest egg faster. Why? I’d rather get the money now than wait for some pie in the sky appreciation promised by some CEO. Look at Tesla, do you believe that it’s going to end well?
The Dividend Investing Plan
What’s the plan? I’m going to buy some dividend ETFs, ones that have a good history of dividend yield and dividend growth. I’ll do this in my 401k and IRA accounts. Then I’ll reinvest the dividends and sit tight. That’s it. I’ll money to it as I go along if I remember too but that’s about as simple as you can get.
Of course, the next question is how do you screen for good ETF’s or stocks? That’s trickier but I’d look for dividend yields between 3 and 6% with low operating fees. An ETF that comes to mind is Vanguard’s High Dividend Yield ETF (VYM).
Note: I’m focusing on ETFs because they’re diversified and work like a mutual fund. Plus, I can get in and out of them faster than I can with mutual funds. Here’s another one, the iShares International Select Dividend ETF (IDV) ETF which has a yield of 6.28% with an expense ratio of 0.48%.
There are many others so I’d have to screen through them but even if I can generate $10,000 a year from dividends, I’d be a happy man.
These 5 tips are the things that need to be in your ‘mind space’ to get you started in dividend passive income and investing. Of course, the one thing I didn’t write about is that the stocks that you buy won’t go up all the time. They’ll drop in price, maybe even crash in some cases. I can’t tell you what to buy or when to sell, but you will have to figure out this risk as well.