With a small pot of savings set aside, there are several avenues to explore passive income opportunities. One of the most effortless is investing in dividend-paying companies. It’s a hands-off approach that lets time do the heavy lifting.
While it’s not a foolproof formula, many legendary investors have successfully tapped into this method. The key lies in following a few smart strategies to help tip the odds in your favour.
Cutting costs
Taxes can take a bite out of your investment profits, so finding ways to reduce that impact is a smart starting point. For UK investors, one of the most effective tools is the Stocks and Shares ISA.
This account lets you invest up to £20,000 a year without paying tax on any gains — a powerful advantage when building long-term wealth. Best of all, opening one is straightforward, with most high street banks and a range of online platforms offering easy access.
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.
The strategy
A solid passive income portfolio often strikes a balance between growth stocks and dividend-paying shares. Growth stocks offer the chance for higher capital gains, while dividends deliver a more consistent income stream — each brings something valuable to the table.
And here’s where the magic happens: reinvesting those dividends can spark the power of compounding, steadily accelerating returns over time.
Smart investors tend to spread their investments across different sectors and global markets, helping to cushion against industry slumps or regional downturns. Many focus on growth stocks to begin with, often achieving between 7% and 8% returns. Even a modest £5,000 investment could snowball into around £30,000 over 20 years.
Adding just £200 a month along the way, and the pot could swell to £166,000 in that time. Shifting that into a portfolio with an average 7% yield would return yearly income of roughly £12,000.
The sooner one starts the better — imagine what it could deliver after 30 years?
What to look for
When building a portfolio for passive income, it’s important to consider where a company may be in 10 or 20 years. Will there still be demand for its products or services? Does it have a long history or reliable management? Is it in an industry with a sustainable future?
Consider British American Tobacco (LSE: BATS), a company that’s built a reputation for consistently delivering reliable and generous dividends. Even during challenging economic periods, it maintains a strong commitment to rewarding shareholders.
It has a consistently high yield, which, over the past 12 months, has fluctuated between 7% and 10.4%. Plus, its share price is up 35% in the past year, which is unusually high growth for a dividend-focused stock.
But its earnings have been volatile lately, with a £15.8bn loss in 2023 offset by a £2.73bn gain in 2024. It also faces significant risks from regulatory and legal challenges to smoking, most recently a £6.2bn charge in Canada. These challenges mean the company has an uncertain future.
For this reason, it’s an example of a company that isn’t ideal for a long-term investment strategy. For that goal, it may be wiser to consider more sustainable dividend-paying companies like Aviva, HSBC, or National Grid.
This post was originally published on Motley Fool
