This is a staff post from LaTisha who writes about investing for beginners, saving and money management for the young adult or recent grad at Financial Success for Young Adults. Visit FSYAonline.com to see more from her.
There are many people looking for passive income today. Mostly because there are only 24 hours in a day. No matter where you live or what you do for a living, there are only 24 hours in a day and you can only be in one place at one time. In those twenty-four hours, you have to eat, sleep and work for your active income. But there is a way to passive dividend income. Dividend investing is a very popular topic for young adults, those who want to retire and even those already retired. That is because investing for income with dividend stocks is a way to generate passive dividend income.
What is the Difference Between Active Income and Passive Income?
Active Income
Active income is what you can bring in during those twenty-four hours in the day. Let’s say that you decide to sleep for 8 hours a day and work for 8 hours a day. Now you have eight hours remaining to enjoy life. That last 8 hours are your leisure hours. You can decide how you would like to spend that time, but if you want to make more money, it will require you to cut into either your leisure time, or sleep time. Recently, as I have been working toward a short-term goal, I have been getting about 6 hours of sleep. That is how I have decided to allocate my time because I am putting in effort now to grow passive income.
Passive Income
The income that you can generate without lifting a finger is passive income. This mostly comes in the form of interest that is compounding. If you have ever imagined being asleep while your bank account grows, then you are familiar with passive income, or at least the thought of it. There are many ways to create passive income, but in order to build it to a level that will sustain you completely, you will have to use a few hours in the day to get there. So with that being said, it takes a person who is willing to work to create passive income. Eventually the time that you have put in to create a passive income will pay off.
How to use Passive Dividend Income
With a little work, you can build up a portfolio of dividend stocks. Well, let me be honest with you. It’s going to take a lot of work. But I know that I don’t see it as work but more like an initial push up a hill, once you have a steady portfolio, you can coast down the hill.
Find the Best Dividend Stocks
In order to find the best dividend stocks, you have to be prepared to do some research. I like to use Morningstar.com for my stock research. There are 3 things to look for participating in dividend stock investing.
Cash Position
The first thing you will want to do is to evaluate the company’s cash position. You can do this pretty quickly by looking at the Total Cash Per Share. This will tell you if the business even has cash on hand to pay a dividend. Of course you will want to compare this number against their competitors to see if it is low or high.
Payout Ratio
The next thing you will want to check is the company’s ability to pay its dividend. The payout ratio is a measurement of how much of one dollar of earnings it takes to pay the dividend. If a stock has a payout ratio of .74, that means it takes 74 cents of each dollar of earnings just to pay the dividend. What if the payout ratio is 1.26? Now the company is not able to pay the dividend with just earnings. That could mean that they are borrowing cash to continue to pay it, or finding the money from somewhere else. Regardless of how they are finding it, a payout ratio that is higher than 1 means that the company could potentially stop paying the dividend, and that is not what you want.
Dividend Yield
The last evaluation point that you will want to look at is the dividend yield. The dividend yield of a stock is a measure of the cash dividend payout versus the price. In basic terms, how much of the stock price is being paid out in dividend form? If a stock is worth 10 dollars a share and the dividend is 1 dollar a year per share, the dividend yield, or rate, would be 10% per year. If you can understand this formula, then you will also see that the dividend yield can change based on that the stock price is. It can also change if the company decides to change the amount of the dividend but most yield changes will come from the daily stock price fluctuations.
If you are looking to generate passive dividend income then be prepared to put in the effort required to research a stock and find a good dividend paying stock for your portfolio – passive income ideas don’t just fall from trees. I will go into more detail on the research required in a future post.
Do you use stock investing techniques such as passive dividend income?
I recently entered the world of dividend investing. I used the Dividend Aristocrats list to choose five stocks I was familiar with. I look forward to watching their progress.
That is a great way to get started. I always say you should start with what you know. How are things going since the latest market crash/comeback?
Great tips – I hope to dip my toe into dividend investing before the year is up – I’ve got 300 left to contribute for my roth, so Im thinking of putting it all into a dividend producing stock.
Wow only 300 left? You are really ahead of the game. I’m going to need all thr way through April to catch up. How do you plan to choose the stock?
Passive income is very appealing, especially the super-low tax rate on dividend income. This blows away the high income taxes we pay on our earned income. Great article LaTisha.
Thanks! Yeah, taxes are definitely a consideration when planning out passive income. It is even better when dividend stocks are purchased in an after-tax retirement account. Then they are tax free! :)
My hubby and I always consider dividend yields when we are looking at investing opportunities. If you don’t you are throwing free money away. We also try to do purchase them with after tax accounts so that we save on taxes. It is a great way to save for retirement without getting pinned just like you mentioned.
It’s great when you can invest with your spouse. That makes the ups even better and the downs not as difficult to take.
Thanks for the easy to follow explainations. I’ve been meaning to get into dividend investing, but haven’t put in the work. Do you have realistic recommendations on cash position, payout ratio, and dividend yields that would make a stock attractive? Thanks!
All topics on the horizon I think Buck. We are trying to provide the basics to dividend stock investing with the use of John’s and now LaTisha’s posts.
I will definitely get into that. But every stock is different especially when they are in different industries and I have to be careful not to be too specific. That way no one will think that I am recommending stocks.
What is Buffet making these days on his dividends?
Good question! I imagine by now he could buy a small country with his dividend payments.
Thanks SPF and LaTisha. Good point. Forgot we have to be careful about dispensing investing advice. Looking forward to your future posts.
Yes, I am using dividends more and more. I like the basic nature of your post.
We’ll get more complex in time but I think there is a gap for a lot of people between the basics and advanced analysis. I figured there must be others out there, like myself, who can learn from folks like LaTisha.
[...] What is Passive Dividend Income? @ Sustainable Personal Finance. Share and [...]
[...] What is Passive Dividend Income? @ Sustainable Personal [...]
[...] What is Passive Dividend Income is up at Sustainable Personal Finance. Are you interesting in buying dividend stocks? [...]
[...] Personal Finance presents What is Passive Dividend Income?, and says, “If you are looking to generate passive dividend income then be prepared to put in [...]
[...] What is Passive Dividend Income? (Sustainable PF) [...]
[...] only problem with Quantitative Easing is that it is not sustainable. When you first learned how to ride a bike you had training wheels. When you were ready to try [...]
[...] PF presents What is Passive Dividend Income? posted at Sustainable Personal Finance.A description of passive dividend [...]