Building a dividend producing passive income portfolio requires thought, time, and education. Today I’m sharing 5 tips for building a dividend passive income portfolio and how you can figure out the right strategy for you.

As I’ve written before, this idea came to me after my wife and I reviewed her 401k at the end of 2020. She had by accident generated a large sum of dividends without even trying. This was the same for me in my 401k as well and we generated $800 in dividends by accident in our trading account.

As 2020 was ending I took some time to look at our 401k balances. This was a good year for our investments, all things considered, but one thing surprised me. There was a line item for “dividend’s earned” and it was quite a large number.  My wife’s 401k earned more dividends than what I made as a salary in my first year out of college! via Passive Investing with Dividends

I couldn’t help but wonder what would happen if I focused on building this income? Could I retire early and spend the rest of my life doing fun things? I think the answer is yes, but I needed to do some research and figure out a strategy forward.

Tip 1 - Research

Before you do anything, and I mean anything, you need to start from the very beginning. That beginning is educating yourself about this particular strategy. My first tip is to join the Reddit group r/Divdends. It’s a very good group with lots of great information for anyone to get started. I go there for the discussion on different stocks, how to set up a portfolio, how to track it, etc.

…you will need time for this to grow.

Besides, the book “Get Rich With Dividends” (affiliate link) is a must-read resource. This book clued me into how to screen for Dividends in my brokerage account and what to look for in the fundamentals of a stock.

Piggy Bank

Tip 2 - Start in a Retirement Account

I’m not a tax professional but what I do know is that generating dividends is a taxable event. If you hold a dividend producing stock in a taxable account like a brokerage account, you will pay taxes on that income. The best thing to do to build up your passive income is to do it first in a qualified retirement account like a 401k or IRA. I chose an IRA because it allows me to hold individual stocks.

Make smart buys now and just reinvest the dividends…

I reinvest all my dividends at no fee in my IRA because I don’t need the income right this moment but in 9 years. This leads me to Tip #3, you will need time for this to grow.

Tip 3 - You Will Need Time

I spoke with a friend recently who’s taking care of his father. His father is very old but was smart in his younger years to amass a sizable stock portfolio. He kept reinvesting his dividends for over 5 decades! When my friend looked at the amount of money that was being reinvested and what the costs were to provide long term care to his father, he stopped reinvesting the dividends. He just took the dividend payout as income to help his father now. What good would reinvesting the dividends be at this stage in his father’s life?

…fees and keeping your transaction costs low is the key to getting the most out of your passive income stream.

His father didn’t touch the stocks and dividends for 50+ years and was able to amass what sounds like a massive passive income stream. Sure it took 50+ years but that was what worked for him, not you. However, you will need time, which is why I’m working on a 9-year time horizon.

Make smart buys now and just reinvest the dividends so that when you reach the end of your time horizon, you will have hit your target.

Time

Tip 4 - Pay Attention to Fundamentals

If you read “Get Rich With Dividends” (affiliate link) you will quickly learn that the author has a specific method for analyzing a stock’s fundamentals. I think this is a solid approach and you should apply this logic but change it based on your risk profile.

For example, he suggests sticking with stocks that have dividend yields between 3 and 5%. I keep to that suggestion mostly but I do own some stocks that generate higher yields than that. Why? Because I can stomach the risk better.

The key fundamentals he looks out for things like the Dividend Yield, Beta, Earnings Growth, and Payout Ratio. I like to also look at the PE Ratio so I can gauge how ‘frothy’ at stock is.

Tip 5 - Diversify

Ever since I read “A Random Walk Down Wall Street” (affiliate link) I’ve been obsessed with diversification. This is why I add dividend producing ETF’s to my holdings. Yes, there’s a fee associated with holding an ETF and there’s a lot of discussion in r/Dividends and in the “Get Rich With Dividends” (affiliate link) book about making your own portfolio to save money on the fees.

My thoughts on the matter are that I’m pushing my risk profile right now and the ETF can help spread that risk around. However, they’re 100% right, fees and keeping your transaction costs low is the key to getting the most out of your passive income stream. I will consider this when I start withdrawing mandatory distributions from my 401k and IRA.

Trend

End Notes

These 5 tips are the things that need to be in your ‘mind space’ to get you started in dividend investing. Of course, the one thing I didn’t write about is that the stocks that you buy won’t go up all the time. They’ll drop in price, maybe even crash in some cases. I can’t tell you what to buy or when to sell, but you will have to figure in this risk as well.

For example, I currently own $GILT because of the high dividend yield. It’s a small company that may or may not be around tomorrow. It’s risky for sure and I’m being a dividend slut. However, a company like $JNJ isn’t going away where. It will be around for years to come and the price was to drop by 50% or more, it will likely continue to pay dividends that you can reinvest if you have a long enough time horizon. This way your average cost per share drops over time and your long-term risk drops.

There’s a lot to think about when adopting this type of strategy and it won’t work well for growth investors, but this works for me.