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Sometimes people wonder how much they’d need in a portfolio to generate enough passive income to live on. Even though this is an honourable goal, I think it’s often better to flip it around and look at a realistic portfolio size to see how much income it could generate. Based on an investor having built up a £50,000 portfolio over several years, here are my findings.
Setting the tolerance
Risk appetite is a big part of the equation that an investor needs to address. From the beginning of building a portfolio, an investor can choose a low-risk strategy or a higher-risk one. This is reflected in the average dividend yield of the portfolio. As a general rule, the higher the yield of a stock, the higher the associated risk.
The best way to think of it is to consider a stock with a rapidly falling share price. The drop would act to bump up the yield in the short term, potentially to very high levels. Yet, if the business is in trouble, the dividend might get cut. This means the yield wasn’t sustainable at such a high point.
A low-risk approach could be to buy an index tracker that provides the income from all the constituents. However, there’s a middle ground whereby an investor with moderate risk can achieve a higher yield than the index average. Part of this relates to holding a diversified portfolio including many stocks. Then, even if one company hits trouble and cuts the dividend, the overall portfolio isn’t that impacted.
A potential inclusion
One stock that I think worth considering for such a portfolio is the Supermarket Income REIT (LSE:SUPR). The stock is up 8% in the last year, with an attractive dividend yield of 7.7%. The fact that the share price isn’t falling rapidly gives me confidence that the yield isn’t being inflated by this factor.
The REIT makes money by investing in UK supermarket properties and earning rental income from long-term leases with major grocery retailers such as Tesco and Sainsbury’s. It’s an appealing business model, because the contracts are usually set for a decade or more, with rents increasing in line with inflation.
Given the conditions set in order to qualify as a REIT, the trust has to distribute the majority of rental earnings as dividends to shareholders. Although it’s not guaranteed, this increases the likelihood of future dividends.
Some flag up the REITs’ risk of being tied to a small number of larger clients. It’s true that if one of the major supermarkets ended the contract, it would be a significant hit to the company. Yet I see this risk as quite small.
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Monetary expectations
If the £50,000 portfolio was built using a middle-risk approach, I believe it could be currently achieving an average yield of 6.5%. This would equate to £3,250 a year. If it were higher risk, I think the yield could be tweaked to 8.5%, paying £4,250 a year. For a low-risk option, the index average of 3.3% would be realistic, offering potential income of £1,640 annually.
This story originally appeared on Motley Fool
