Starting from scratch, here’s how I’d make passive income from dividend stocks in 2024

Businesswoman analyses profitability of working company with digital virtual screen

I can’t think of a better month to start investing than January. And the best bit is that I wouldn’t need much cash at all to begin generating passive income via the stock market.

If I had my time again, here’s how I’d do it.

Avoid the taxman

The first step would be to open a Stocks and Shares ISA. This ensures the taxman can’t get his or her mitts on any of the money I eventually receive.

Now, the most I can put in an ISA in one year is currently £20k. But I reckon few people manage to hit this limit. That’s fine — most providers ask for just a few pounds to get cracking.

The key is to get into the habit of diverting some money into my ISA every month.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Here’s what I’d buy

Just like there are good businesses and bad businesses, there a good and bad dividend stocks.

The former ones tend to be companies in stable industries where profits are fairly consistent. It’s this predictability that allows them to build a track record of returning more cash to shareholders every (or nearly every) year. Think of firms like Diageo or Unilever.

Bad dividend stocks tend to be those who have the opposite characteristics, namely wobbly earnings and irregular payouts. Big debts can also be a red flag.

Staying safe

The really important thing to understand about any dividend stock is that the passive income it throws off is never 100% guaranteed. For this reason, I need to make sure I’m not overly invested in one particular sector.

So if I owned shares in one housebuilder (and I do), I probably wouldn’t own another (and I don’t). If I owned stock in a consumer goods giant, I’d possibly steer clear of other companies in this space.

Done properly, this means I won’t be thrown off course if one or two of my holdings have a bad year.

Another route

If all this sounds like a faff, there is another option. This involves buying what’s known as an index fund, an investment that tracks the return of the market.

So if the FTSE 100 index (the Premier League of UK stocks) increases 3% in value in one year, I’ll get that 3% too, minus fees. I won’t beat the market, but I won’t lag it either.

The brilliant thing about a FTSE 100 index fund in particular is that it pays out dividends! Moreover, my money is spread over many, many stocks rather than a few I’ve selected.

A down year for the UK market means the value of my holding might (temporarily) fall. But this is why being a Fool is important. It’s the long-term result we focus on.

Speaking of which, there’s something I can do to increase the chances of that outcome being positive…

Receive, reinvest, repeat

Since I don’t need this cash to pay bills today, I’d reinvest everything I receive back into the market. Doing so allows me to benefit from compound interest.

It’s this strategy that helped make Warren Buffett one of the wealthiest men on the planet. And it could help me build a lovely nest egg too.

Naturally, the income I receive would be small initially. But just beginning is the most important step.

Pound coins for sale — 51 pence?

This seems ridiculous, but we almost never see shares looking this cheap. Yet this recent ‘Best Buy Now’ has a price/book ratio of 0.51. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 51p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 8.5%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo Plc and Unilever Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.