Here’s how I’m investing in dividend stocks to generate additional income!

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Dividend stocks provide me with regular income through quarterly, biannual or annual payments. These dividends are by no means guaranteed — just look at what happened during the pandemic — but many companies have an impressive track record of growing and paying dividends for decades on end.

How I use dividend stocks

I’ve got a sizeable pot invested in stocks with strong dividend yields — it’s worth remembering that the dividend yield I get is always going to be reflective of the price I pay for the stock and not the spot price.

But right now, I don’t need the income. So I invest my payments to benefit from something called compound interest. This is the process of reinvesting my profits and earning interest on my interest.

For example, if I had £1,000 in a dividend stock, and reinvested my dividend payments every year, after 30 years I’d have £4,467 if I assume an average 5% yield. That’s a great return. And in the future, I can start taking dividend payments from this larger pot to top up my income.

Where am I investing?

As I’m investing for the long run, I’m looking for stocks that are unlikely to fail. I also want to find stocks offering a sustainable dividend yield and ideally firms with a good track record of paying a dividend year on year.

It’s important to note that really big dividend yields are often unsustainable, and therefore I’m steering clear of companies offering 12% yields, unless I’m content with them cutting the dividend at some point.

My top picks

Lloyds (LSE:LLOY) is among my favourite dividend stocks. It currently offers me a 4.35% dividend yield, and I think there’s plenty of potential for growth in the share price. Higher interest rates mean higher margins for the bank. And interest rates are due to rise further this year as inflation moves towards 13%. The bank has already seen its margins improve over the last year.

While the forthcoming recession may create challenges in the near term, the long-run outlook is positive, in my opinion. The bank has fairly low-risk operations with the majority of its loans in the property sector. I also see strong long-term demand for property outstripping supply, and thus plenty of demand for mortgages.

Vistry Group (LSE:VTY) is a housebuilder stock that’s growing at an impressive rate. It recently announced that it expects pre-tax profit for the year to be at the top end of market forecasts — £417m. That’s way above 2021 (£319m) and double the profit levels achieved prior to the pandemic. So it’s certainly a growing developer.

It is also offering an attractive dividend yield of 6.7%. And that’s one of the advantages of buying on the dip — the yield is inflated. The firm recently said that demand remained strong and forward sales increased to £2.9bn from £2.7bn.

With interest rates rising, there could be some short-term challenges here. But in the long run, I’m confident demand will remain very strong. After all, there’s an acute shortage of houses in the UK.

The post Here’s how I’m investing in dividend stocks to generate additional income! appeared first on The Motley Fool UK.

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James Fox owns shares in Lloyds and Vistry Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.