Often, when Canadians think of the stock market, they immediately think of the wild price swings and chance to make or lose a lot of money. And while capital gains or losses obviously matter, the passive income your portfolio generates is just as important.
Even if you are not an older investor nearing retirement, the dividends your portfolio earns can significantly boost the compounding effect over the long haul, especially when you reinvest them. Those reinvested dividends quietly accelerate your returns year after year.
Plus, the compounding effect becomes even more powerful inside a TFSA. Since you don’t pay taxes on any of the dividends, you can reinvest every dollar and build your passive income stream much faster.
And the best part is that creating a strong, reliable, and steadily growing stream of passive income is actually simple. All you need is the patience and discipline to find high-quality companies that are well-established and pay a consistent dividend. It’s even better when those companies increase their payouts over time.
So, with that in mind, let’s look at exactly how much money you would need to invest to earn $500 a month in tax-free passive income inside a TFSA.
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How much does your portfolio need to yield to earn $500 a month in passive income?
Figuring out how much it takes to earn $500 a month of passive income, or $6,000 per year, depends entirely on the stocks you own and overall yield of your portfolio.
The higher your portfolio’s yield, the less capital you need to invest. For example, if your portfolio has an average yield of 3%, you would need roughly $200,000 inside your TFSA to generate $6,000 per year in passive income.
However, if your portfolio had an average yield of 5%, you would only need about $120,000 to earn the same $500 per month in dividends.
So, the higher the yields of the stocks in your portfolio, and therefore, the higher your portfolio’s overall yield, the less capital you actually need to invest to generate $500 a month in passive income.
However, it’s crucial to understand that while higher yields look more appealing, they can also signal risk. Sometimes, a high yield is the result of a falling share price or financial pressure on a company, which can increase the odds of a dividend cut.
Because of that, it is crucial to make sure the stocks you are buying have sustainable dividends and not just attractive yields.
Dividend growth stocks can accelerate the compounding effect
Although buying higher-yield stocks can help you generate $500 per month in passive income sooner, long-term investors know that dividend growth stocks can help supercharge the compounding effect of your TFSA.
When you reinvest dividends, you naturally own more shares over time. That alone boosts the passive income that your portfolio generates every year. However, when the stocks you own are also increasing their dividends every year, you get a double benefit.
Now you’re earning more income from a bigger number of shares, and each one is paying you more than it did the year before. That’s how your passive income really starts to snowball.
Over the long haul, owning these dividend growth stocks makes a massive difference. This is especially true because a company that’s consistently raising its dividend every year doesn’t just grow your income, it also creates steady share price growth.
That’s why many passive income seekers prefer high-quality dividend growth stocks like Enbridge (TSX:ENB).
Enbridge is an ideal stock for passive income seekers because it provides essential services to the North American economy. This allows it to consistently earn billions in cash flow every month, allowing it to continuously invest in future growth while raising the dividend annually.
In fact, Enbridge has raised its dividend annually for three straight decades. And on top of the dividend growth, it offers an attractive yield as well, currently sitting at roughly 5.6%.
So, if you’re looking to build a passive income stream and generate $500 or more of tax-free income every month, it’s essential to find the highest quality dividend growth stocks to buy and hold for the long haul.
