The great thing about stocks is that you don’t have to put all your money into one asset. You can build a diversified portfolio with different stocks, each producing income. As a result, you can hedge your bets and ensure that your income sources come from different sectors and industries.
Pitfalls to Avoid When Investing for Passive Income
A mistake beginners often make when looking for passive income is to simply buy stocks with the highest returns. Who wouldn’t want to earn a 7-10% return on their capital?
Yet there are often reasons why a share’s return is extremely high. It could be a poor balance sheet, weakening business prospects or even concerns about the viability of the dividend itself. Increasing returns are often associated with a falling share price. You don’t want to buy a falling knife.
Look for total returns and best-in-class companies
What’s the point of earning a high return if that stock is falling fast, or if that dividend is in danger of being cut?
One of the best ways to avoid this is to build a dividend stock portfolio total return. The best dividend stocks are those that regularly increase their dividends because their earnings/cash flows are also increasing. With these shares you get the combination of attractive income and steady capital growth.
If you are looking for ideas to build a passive income portfolio, this is how I would structure it.
Safe Passive Income Tools
A utility share such as Fortis (TSX:FTS) can be a great structural ballast in a portfolio. It is not growing much (about 4-6% per year), but it has a very stable, regulated transmission/distribution activity for electricity and natural gas.
Profits do not fluctuate too much from one year to the next. You can hold this stock through several market cycles, and it will likely deliver mid-to-high single digit total returns.
It yields just 3.5% today. However, it has a 52-year dividend growth track record unmatched by any other stock in Canada.
Property
Real estate shares are especially nice if you want a passive income every month. Real estate investment trusts earn monthly rent, and they return most of that income to shareholders each month.
Granite REIT (TSX:GRT.UN) is a defensive Canadian REIT. Granite operates institutional-level logistics, manufacturing and warehousing facilities in Canada, the US and Europe. It has long-term leases with high-quality tenants. It yields 4.4%, but has increased the benefit for fifteen years in a row.
Financial data
Canada is known for its Big Six banks. Every Canadian investor should have some exposure. Royal Bank of Canada (TSX:RY) is the largest and perhaps best bank.
Although it trades at a premium (and a lower 3% yield), it has a top franchise in Canada and a great balance sheet. Banks can be economically sensitive, so position size should be adjusted accordingly. I prefer to own the best in the industry for a stable, growing passive income.
Energy
Energy stocks are cyclical and can be a bit riskier. However, there are a few energy stocks that are very well managed. Their dividend track records are exceptional. Canadian natural resources (TSX:CNQ) is in a class of its own. It has increased its dividend at a compound annual rate of 21% for 25 years.
The company produces energy with factory efficiency. It has a strong balance sheet, high profitability and decades of energy reserves. If you want passive income, own the best of the best in the industry (like CNQ), and you will do very well in the long run.
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