Building a portfolio of ASX shares that can generate income alongside your usual earnings is a great way to enhance your financial security and diversify your income streams.
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How to get started
Generating substantial earnings from dividends does however demand substantial amounts of savings, and getting there can seem an insurmountable task.
Therefore, it's good to start relatively small, and use the power of compound interest to your advantage.
Today, I'm looking at what can be built up from a base of $20,000.
To generate the target of $5,000 per year in dividend income, you'd be looking at amassing about $100,000 in capital.
I'd argue you could generate about 7% per year from a combination of capital increases – share price growth – and dividends.
If you start with $20,000 in savings, I'd aim to save a further $100 per week.
Over a nine-year period, and assuming a return of 7% per year, you would have $99,055 at the end of this time.
If you'd like to tweak the calculations yourself, head over to the Federal Government's Moneysmart calculator and have a play around.
Once you hit the $100,000 mark, if you choose, you could start taking your dividends out as an income stream rather than reinvesting them.
So at this stage, what sort of stocks would you be looking to own?
Building an income-generating portfolio
Firstly, it's a good idea to keep in mind whether the stocks are paying franked dividends.
A fully-franked share comes with a 30% tax credit for the tax already paid by the company, meaning you do not have to pay your full tax rate on the dividends earned.
In terms of trying to hit our target of $5,000 a year, you'd need to be aiming for a dividend yield of 5% – but keep in mind this doesn't take into account any tax you'd need to pay.
Tolls roads operator Atlas Arteria Ltd (ASX: ALX) is a reasonable company to consider, as it is currently paying a 9% yield, with brokers expecting a relatively strong yield to be maintained for the next few years.
Gas pipelines operator APA Group Ltd (ASX: APA) is also a good fit, paying a 5.39% dividend, albeit only 31% franked.
Investment company Wam Active Ltd (ASX: WAA) is paying 7.4%, while Argo Investments Ltd (ASX: ARG) is paying 4.18%.
Among the banks, Westpac Banking Corp (ASX: WBC) is paying 4.47% while Bank of Queensland Ltd (ASX: BOQ) is paying 6.1%.
Retailer Universal Store Holdings Ltd (ASX: UNI) also has a healthy dividend yield at 6.22%.
So as you can see, there are plenty of stocks around which can deliver decent yields once your savings have hit the target.
