How I plan to retire early with £1,000 a month of passive income

 Provided by The Motley Fool

Mark David Hartley

Passive income is the perfect way to continue receiving an income after retirement. My pension will only stretch so far, so if I want to retire early, I’ll need something extra.

I think the best way to do this is with a portfolio of shares that pay dividends.

How dividends work 

A dividend is like a small gift that companies pay their shareholders every year as a thank-you for investing in them. A 5% dividend yield on a £1 share would pay me 5p for each share I hold. This is in addition to any returns made if the share price increases.

Once the passive income stream has been established, I can begin withdrawing my returns as needed.

Dividend yields change regularly, so it’s impossible to know how much I’ll receive each year. But with a portfolio of well-selected stocks, I can aim for a conservative average of around 5%.

How my strategy could work

I’ll use the small-cap iron casting and machinery firm Castings  as an example.

Its 5% dividend yield is lower than many other UK stocks but it has an excellent track record of making regular payments. I’d aim for a good mix of reliable low-yield dividend shares and less reliable high-yield shares.

Furthermore, it’s currently estimated to be trading at 58% dividend yieldso could go up from here. I don’t want to dive into an overvalued dividend stock that could lose value and negate any returns I make from dividends.

On the downside, Castings earnings are forecast to grow at only 3.1%, slower than the UK average of 12.6%. Still, the dividend payments make it worthwhile.

I’ve calculated that I could reach my goal of £1,000 a month in passive income in 20 years with the following strategy.

My outcome is based on a 5% dividend yield with semi-annual payments and an expected 0.2% annual dividend increase. I’ve also calculated an expected 6% annual share price increase. This is based on the past performance of an average basket of well-performing FTSE stocks.

• First, I’d invest £12,000 into a portfolio of shares similar to Castings

• I’d use a dividend reinvestment plan (DRIP) to put any dividends earned back into the investment

• I’d contribute an additional £200 a month to the investment

Risks

There are risks involved with such a strategy. I can’t guarantee the dividend payments will be consistent, or remain at 5%. The share price of any stocks I include could also fall, resulting in financial losses.

For this reason, I need to carefully research all the stocks I add to my portfolio. I should ensure they have a solid history of growth potential and a track record of making reliable dividend payments.

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