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3 simple steps to take when seeking to generate a passive income from dividend stocks

Generating a passive income from your portfolio may not seem all that challenging in the short run. After all, it is fairly straightforward to buy high-yield stocks that provide a generous level of income on a regular basis.

However, ensuring that your income continues to beat inflation and is sustainable over the long run can be more difficult. Furthermore, making sure that the size of your portfolio continues to grow in order to produce a rising passive income may also be challenging.

Here’s how you can achieve those objectives in three simple steps. They could allow you to enjoy a generous passive income over a prolonged period.

Beating inflation

A high yield today may not always stay ahead of inflation. Some businesses that have high income returns may face an uncertain future which means that their dividend growth rates are somewhat lacking. This can mean that the real-terms value of your passive income gradually falls, thereby causing a decline in your spending power.

As such, ensuring that your passive income can grow at a faster pace than inflation is crucial. In order to do so, focusing on a company’s financial prospects, its growth strategy and its dividend affordability could be useful. Together, they may paint an accurate picture of how quickly its shareholder payouts will rise in the long run.

Sustainability

As well as seeking dividend growth, the sustainability of a company’s income return is of great importance to investors. In other words, if a company’s business model fails to provide scope for consistent dividend payments over a variety of economic periods, it may lead to a volatile passive income that is unable to sustain your lifestyle during recessionary years.

Therefore, ensuring that a company’s business model can deliver high levels of net profit and positive free cash flow during a variety of economic conditions could be worthwhile. This may naturally mean that you pivot towards defensive stocks which have a solid track record of delivering resilient dividends. While investing in defensive stocks may mean there is reduced scope for capital growth in some cases, it could improve the chances of receiving a robust and reliable passive income over the long run.

Reinvestment potential

Reinvesting the dividends paid from your portfolio holdings may not be a priority. However, it can lead to an improving long-term outlook that enhances your passive income in the long run.

As such, living within your means where possible and seeking to spend less than the dividends received from your portfolio could be a prudent strategy. It may provide scope to invest in appealing income and growth opportunities, while providing a cash buffer in case the dividends from your portfolio come under pressure during a bear market. This could produce greater consistency and longevity when it comes to living off a passive income in retirement and older age.

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The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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