One way to make passive income is from buying a dividend share. Over time, the dividends declared by the company will be paid into my account. This income can build up, making it useful money I don’t have to work hard for.
This is great, but there are a few things I can do to go from owning one dividend share to ramping up my passive income potential from the stock market.
Making use of the ISA wrapper
The first trick I’ve used is to house my dividend shares within a Stocks and Shares ISA. This is a provision that’s available to all, with a limit of £20,000 invested per year. My investments within this amount in the ISA are covered by a tax wrapper. This means that I don’t pay dividend tax on any income I receive in this regard.
The benefit of this can be seen from a simple example. Let’s say I receive £3,000 in passive income a year from dividends. If it’s within my ISA, I get the full £3,000. Yet if not, then my dividend allowance of £2,000 is used up. Depending on how much other income I make, the excess £1,000 could be taxed up to a rate of 38.1%!
In order to reduce the potential of cutting my net passive income, housing my stocks in a Stocks and Shares ISA makes sense.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Checking the payment dates
The second tip I like to use is to see when the next dividend payment is due. For example, a company might pay an annual dividend with a current attractive yield of 8%. But if I see this a week after the annual dividend has been paid, it doesn’t make much sense to invest right then. To increase my passive income, I’d rather look for other companies that will be paying a dividend sooner, or one that pays out on a quarterly basis.
The key point here is that as long as I own the share before the ex-dividend date, I’ll receive the dividend on the payment date. Admittedly, I don’t want to try and get too clever here. Attempting to perfectly time these things never ends up going well, in my experience.
But for dividends that are paid annually, it does make sense to consider when it will next be paid so that I can avoid holding a stock for many months before getting any sniff of income.
Increasing passive income consistency via diversification
The final point to help me increase my passive income is to build a larger portfolio of dividend stocks. In one way, this will obviously increase my income, as I’m investing more money. But the logic here is actually more to do with diversifying my risk and blending my dividend yields together.
By holding a dozen stocks versus just one, the ability for me to consistently generate income increases. If I hold one stock and the company cuts the dividend, my income is significantly hit. If one out of 12 stocks cuts the dividend, the impact is much less.
Further, I can even achieve a higher overall dividend yield by owning multiple stocks (with a lower overall risk) than by just owning one.
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Jon Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
George is Digismak’s reported cum editor with 13 years of experience in Journalism