Passive income is a holy grail for many investors, but it's a lot easier to want it than it is to make enough of it from your holdings. Buying shares of any old dividend stock simply won't do; you need a strategy that's right for your goals and your means.
So, let's explore three strategies that can help you invest for passive income, starting with one technique that you'll need a bit of patience to employ correctly.
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1. Dollar-cost averaging
Dollar-cost averaging is a slow and safe way to build up a position in a dividend stock. Rather than making a lump-sum investment, the strategy calls for making a series of smaller purchases over time.
That means it's a more approachable strategy if you don't have much capital on hand or if the company you're targeting has a low dividend yield. And since your purchases are made across a period of weeks or months or even longer, the impact of day-to-day fluctuations on your cost basis won't be as large, nor will your risk of getting your shares diluted, since only part of your final position will be vulnerable at any given time.
You can dollar-cost average into a high-yield dividend stock if you want, but it actually makes more sense to do it for lower-yielding stocks, especially during a bear market when price levels are broadly dropping.
For example, it would cost you about $20,000 -- a very large amount for a lump-sum purchase -- to buy enough shares of pharmaceuticals company Viatris (VTRS -0.09%) to generate $1,000 per year in dividends, since its forward yield is only 5%. But if you broke up that total investment into 10 manageable purchases of $2,000, or even 20 purchases of $1,000, you would still get the same amount of passive income at the end of the process.
The trick is that you need to be both patient and consistent to make it work, and the main drawback is that you don't get the full $1,000 per year until the buying process is finished. But if the stock tanks or the dividend gets cut before you're done accumulating enough shares, you can also decide to deploy the rest of your capital elsewhere, which limits your risk while you're building your position.
2. Lump-sum investing
The most direct way to make $1,000 in annual passive income is to find a dividend stock with a high yield, and then buy as many shares as necessary to hit the target inflow. For a stock like AFC Gamma (AFCG 0.17%), a real estate investment trust (REIT) with an absurdly high forward yield of 18.6%, you could make a lump-sum investment of only $5,376. That's quite an attainable sum, even if it might take a few months to save up.
But there are a few reasons this strategy needs to be used with caution. First, if you concentrate your entire passive-income portfolio into one stock, you'll be very vulnerable if anything goes wrong with the business. So ideally, you should make several lump-sum purchases of stocks with similar yields to ensure that your income stream is a bit more resilient.
The other caveat is that many of the companies suitable for lump-sum investing are REITs, which typically rely on debt financing to buy properties and then rent them out. They sometimes also issue new shares to raise capital, and if you buy in right before a stock offering, your stake will get diluted, and your realized dividend yield will be smaller than what was advertised. Therefore, be sure to vet the stock's financials and growth model before investing, as lump-sum investment will leave you quite vulnerable. Also keep in mind that companies with very high dividend yields often are apt to cut their payout if the economy or their business slows.
You'll also be more vulnerable to fluctuations in the price of the stock, as all of your shares will have the same cost basis.
3. Look for high rates of dividend growth rather than high yields
For very patient investors and those without much capital, perhaps the best way to make $1,000 in passive income annually is to invest in stocks with a high rate of dividend growth. Doing either a large purchase or several smaller purchases will work just fine, as long as you're willing to wait long enough for the dividend growth to develop into your target level of income.
Take pharmaceuticals company AbbVie (ABBV -0.38%) as an example. With its forward yield of about 3.8%, it would take an investment of roughly $26,385 to make a grand per year, which is way too much to do in one shot, and also a bit large to easily dollar-cost average into a position in a short period.
But over the past 10 years, AbbVie's annual dividend per share increased by an average of 15.4% per year. And if it continues to grow at that rate, you could get to $1,000 in passive income annually by investing only $10,000, reinvesting your dividends, and waiting 6.8 years for the growth to accumulate.
Of course, that assumes AbbVie's dividend yield remains roughly the same in the period, which it might not, and also that its dividend won't get cut, which is always a possibility. Still, you end up getting the same amount of passive income as the other methods with less than half of the principal, which isn't half bad at all.
