Image source: Getty Images
Earning passive income is a key goal for many stock market investors, myself included. Fortunately, there are many UK dividend stocks that can help those trying to turn this dream into a reality.
One of the main benefits of dividend investing is that it does not involve the same upfront costs as other methods of generating passive income, such as purchasing rental properties.
With that in mind, here's how you'd aim to earn £308 in monthly dividends starting with £5,000 in savings.
<h2 class="wp-block-heading" id="h-finding-the-right-dividend-stocks“>Finding the Right Dividend stocks
When buying stocks for income, I prefer to invest in well-established companies with a strong track record of paying dividends to shareholders.
While more speculative high-yield stocks are tempting, I value the stability that Dividend Aristocrats offer, even if the yields aren't as attractive.
He FTSE 100 and FTSE 250 They have quite a few such stocks in their ranks, so British passive income investors are spoiled for choice.
An action to consider
To illustrate what type of stock I'm talking about, I'd like to highlight a FTSE 100 company that has grown its payouts regularly over the years: CHILL OUT (LSE:REL).
This company operates in the information and analytics sector and serves a variety of industries including scientific and medical research, legal and risk management.
A 1.7% dividend yield may not sound too exciting, but I like that its stable cash flows and forward dividend coverage of two times earnings indicate a solid margin of safety.
Plus, business has been booming. In five years, the share price has almost doubled, outperforming the FTSE 100 index by a considerable margin.
There is also great potential for the company to leverage generative ai across its product range. For example, the company recently developed Lexicon+ aia legal research tool powered by artificial intelligence.
Through machine learning algorithms, this product can optimize the time needed to analyze documents and offer personalized recommendations for lawyers. It's easy to see how future technological advances could boost the customer offering.
The company's price-to-earnings (P/E) ratio of 37 is much higher than most FTSE 100 stocks, which could be a risk to further growth. However, I think it's a stock worth considering, especially if the share price falls; I plan to add it to my own portfolio next month.
Portfolio diversification
While a dividend aristocrat like RELX could create a steady stream of passive income, investors should remember that dividend payments are not guaranteed.
To mitigate the risk that any of the stocks I own will reduce payouts or cancel them entirely, I spread my investments across a variety of companies and sectors.
Consequently, diversification is a great way to ensure that all my passive income isn't in one basket.
Let compounding do the work
So back to my initial savings fund of £5,000.
With a long-term time horizon and enough good luck, if I invested my initial sum in a dividend share portfolio like RELX, it could have a good chance of growing to £73,927 after 35 years.
That would require a compound annual growth rate of 8%, which is in line with the FTSE 100's historical average.
If I earned a 5% return on my entire portfolio, I would earn my target sum of £308 in monthly dividend distributions. Nice.
It's time to put my passive income plan into action!
