Over the past 4 years I have experimented with many different passive income ideas. Some of these ideas were successful (i.e. CD Ladder), while others never materialized into anything other than a lot of wasted time (i.e. peer lending). One of my passive income streams was a huge success for a couple years and then fell flat on its face. Regardless of the results, I continue to stay focused on testing out new passive income sources.
I am a firm believer in diversifying my income streams to protect my family’s finances. While the majority of our income comes from my job, I am working hard to diversify it into multiple sources instead of one. In order to expand our income sources, it is critical that I build them to be as passive as possible.
One income stream that does not require a lot of my time are dividend paying stocks. In my opinion, these investments offer the best source of passive income possible. While some may argue that investing in stocks requires a lot of time and can be risky – I disagree. This income stream has now become my top priority, which is why I have highlighted some important points below.
How Can Dividend Paying Stocks Provide Passive Income?
The one source of passive income that has been the most consistent and successful for me is my portfolio of dividend paying stocks. No, I am not talking about the highest yielding stocks that offer a double digit yield. I learned the hard way that a stock with a 15% yield is too good to be true! I am actually referring to low risk, blue chip stocks that probably seem boring to most investors.
There is nothing glamorous about these investments that I am talking about. The companies that I invest in have low price to earnings ratios (under 20), a moderate yield (between 2.5% and 6.0%), and have a solid history of raising dividends each year. Many of these companies can be found on the S&P 500 Dividend Aristocrat Index.
The stock portfolio that I am building offers a low risk and steady form of passive income. Here are a few reasons why I believe blue chip stocks offer the best source of passive income.
Yield on Cost – If you don’t know what yield on cost (YOC) is and want to invest in dividend stocks, you should learn. One of my holdings is Consolidated Edison (ED). The stock currently offers a modest dividend yield around 4%. Since I purchased these shares several years ago, my return on investment is actually much larger – 7.4%!
Since this company has a history of increasing their dividend annually, my shares keep earning higher and higher interest! If you build your portfolio the correct way and target blue chip dividend stocks, your yield can compound every year without lifting a finger!
Automated Investment Plans – If you think you don’t have enough money or time to start investing, consider an automated investment plan (AIP). For as little as $25 per month, investors can begin purchasing fractional shares in a company, which can add up in the course of a year. Online brokers such as ING Direct Investing offer automatic investment plans as well as investing in companies directly.
Automated investment plans are also a great time saver, provided you do your research up front and select only the best dividend stocks. Once your plan is setup, money is taken out of your checking or savings account each month and used to buy shares in the stock without any work on the investor’s part.
Dividend Reinvestment Plans – Dividend reinvestment plans (DRIPs) are perfect for the passive investor. Once you own shares in a top dividend stock, a DRIP can be setup which will automatically reinvest dividends back into additional shares of stock. As long as you have done your due diligence, a great way to earn compounding interest is through reinvesting your dividends.
A DRIP can be setup for companies you own in your portfolio through your online discount broker or through the company in which you purchased shares from. There are usually no commissions to reinvest your income into new shares, so a DRIP will save you time and money on brokerage fees!
Investing in Dividend Paying Stocks
While there are risks involved with investing your money in the stock market, investors can take steps to protect their portfolio. Screening for only the top dividend stocks and not overpaying for them are a few ways that I am able to protect my investments. A well-built portfolio can withstand any stock market correction or downturn.
Investments like a certificate of deposit and high yield savings account usually offer protection on your initial investment. However, with current interest rates so low (under 1%) for many of these investments, it has become difficult to justify the protection. For that reason, I have started to move money out of my CD’s (as they expire) and invest in top dividend stocks. Building these investments will provide a steady stream of income for many years.