Passive Income: 2 Truths and 1 Myth About Dividend Stocks

Dividend stocks like Pembina Pipeline can provide real passive income.

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Have you ever wondered whether it’s possible to earn passive income from investments? It’s an important question to ask. Everybody wants to have a comfortable retirement, and passive income is what makes that possible.

The unfortunate part is that many “passive income” opportunities aren’t passive at all. Being a landlord involves manual labour, affiliate marketing is a full-time job, and most other passive income opportunities you’ve read about are in the same category.

Dividend stocks are a rare exception. If you invest enough money in dividend stocks, you can quite literally get passive income coming in with no extra work. It’s a risky game, though, so read on to learn two truths and one myth you must know before you start investing in dividend stocks.

Truth: Dividend stocks pay out passive income

Many stocks pay out passive dividend income. That’s 100% true. Take Pembina Pipeline (TSX:PPL), for example. It’s a dividend stock with a 5.8% yield. If you invest $100,000 in this stock, you’ll get $5,800 back in passive income each year – assuming the dividend doesn’t change. Unlike fixed-coupon bond interest, dividends can easily go up, go down, or disappear entirely. The trick is to find ones with a real shot at rising payments over a long period of time.

Pembina Pipeline might just be one. It’s a pipeline company that “rents” space on its pipes to companies that need to transport oil and gas. Typically, the contracts it signs with customers last for several years, so the revenue keeps coming in whether the price of oil goes up or down. It’s a pretty resilient business model. So, the dividend will probably continue to be paid. In fact, if Pembina can keep adding new customers and building infrastructure to accommodate them, then its dividend may even rise over time.

Truth: Dividend income can grow over time

Speaking of rising dividend income:

It can definitely happen.

If a company is successful, meaning profitable and gradually growing its earnings, then it can raise its dividend a little bit year after year. If you take PPL stock as an example, it has grown its dividend by 5.5% per year over 10 years. That’s a pretty good growth rate. If the company can keep it up, then it could eventually double its dividend. Today, PPL yields 3.5%, but in a best-case scenario for the business, it could easily rise to 7% or more over time. I don’t mean to say that that will happen –it could easily not happen – I bring up the point to draw attention to what is possible with dividend stocks.

Myth: It’s possible to get risk-free passive income that covers all of your expenses with small sums of money in dividend stocks

And now for the final item on our list: a widely believed myth about passive dividend income:

That you can get a lot of it with little invested.

Unfortunately, this isn’t really the case. You may have seen articles online promising things like $10,000 per month in passive income from a $10,000 investment, or $1 million in cumulative dividends after a few years. That sounds nice, but it isn’t really the way it works. As a rule of thumb, you should expect a yield between 3% and 4% on a well-diversified dividend portfolio. So, $3,000 to $4,000 in annual cash payouts for every $100,000 invested. It may take a while to cover your expenses at that kind of yield, but if you keep at it, you’ll get there.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends Pembina Pipeline. The Motley Fool has a disclosure policy.

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