How I鈥檇 invest in dividend shares to make a passive income for life

I think that investing money in dividend shares could lead to a relatively high and growing passive income over the long run.

asx dividend shares represented by tree made entirely of money

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Dividend shares could prove to be a sound means of obtaining a passive income for life. At the present time, they offer significantly higher income returns than other mainstream assets, such as cash and bonds.

Furthermore, many stocks have solid financial positions that mean their dividends are very affordable. They could also produce strong dividend growth in the coming years that outpaces inflation and provides an investor with an increasingly sound financial outlook.

Reducing the risk of loss from dividend shares

Dividend shares offer a substantially higher passive income than other assets due to low interest rates and the effect of the 2020 stock market crash. Low interest rates mean that the income returns available on cash and bonds are below inflation in some cases. Meanwhile, many income stocks have not fully recovered from the market decline. This may mean that they offer above-average yields at the present time.

Of course, the higher income return from dividend stocks comes with greater risk. A weak global economic outlook means that some companies could experience challenging operating conditions. As such, diversifying among a wide range of companies, sectors and regions could be a shrewd move. It may reduce risk and provide an income investor with a more reliable return in the coming years.

An affordable passive income

Alongside diversification, enduring that dividend shares can afford their current payouts is crucial when seeking to make a passive income for like. A company with a generous yield that is unaffordable is unlikely to provide any added value to an income investor.

Assessing a company鈥檚 financial position can provide guidance on the likelihood of it experiencing difficulties in paying dividends. For example, low debt levels and defensive characteristics may help in producing a robust income return. Similarly, a company鈥檚 dividend cover provides an insight into the amount of headroom it has when making dividend payouts. It is calculated by dividing net profit by dividends. A figure of more than one suggests it has room to spare when rewarding shareholders for its success via a dividend.

Dividend growth opportunities

Dividend shares that can increase shareholder payouts at a fast pace may become increasingly valuable. The loose monetary policies being followed in major economies could lead to higher inflation. Therefore, a passive income that can grow at a high rate could be required in the coming years to maintain, or increase, an investor鈥檚 spending power.

A company鈥檚 capacity to raise dividends at a fast pace is closely linked to its financial outlook. Therefore, buying shares in companies that could benefit from long-term industry growth trends, or those businesses that have a competitive advantage over their peers, may be a sound move. They may be able to produce strong dividend growth that further enhances an investor鈥檚 passive income in the coming years.

Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a聽disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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