Buying and holding high-quality blue-chip stocks is a popular tactic to earn a reliable passive income. After all, these are some of the most mature businesses in the stock market, with steady cash flows and profits. As such, they are often a lucrative source of consistent dividends for potentially decades to come.
The London Stock Exchange is home to a wide range of these enterprises, with many now sitting comfortably in the FTSE 100. And if left to run, a modest portfolio of blue-chips can grow into a substantial nest egg.
In fact, starting with just £25,000 is more than enough to launch the journey to earning an extra £1,000 each month passively.
Leveraging blue-chip stocks
Despite offering lacklustre growth prospects, large-cap stocks still produce meaningful returns. Since its inception, the UK’s leading large-cap index has generated close to an 8% total gain a year on average – half of which typically comes from dividends.
However, investors who successfully picked individual winning businesses rather than relying on an index fund have achieved significantly better results. For example, AstraZeneca‘s sitting on an 11.3% annualised return over the last 10 years. Meanwhile, RELX has delivered closer to 13%, with Experian coming in even higher at 15.7% over the same period.
Combined, that’s a 13.3% average annualised return from both capital gains and shareholder payouts. While a 5.3% difference doesn’t sound like much, when compounded over decades, it makes an enormous difference.
To demonstrate, £25,000 invested at 8% a year for 20 years would compound to a portfolio worth £123,170. That’s not bad. But it pales in comparison to the £352,215 earned by the stock-picker. And when following the 4% withdrawal rule, that’s the difference between earning £410 a month and £1,174.
Stock-picking risks and rewards
We’ve already seen the power of earning just a few extra percentage points of returns each year from stock picking. But sadly, this better performance comes at the cost of higher risk.
After all, not all stocks go up, and there have been plenty of blue-chip losers over the last decade. BT Group‘s (LSE:BT.A) a perfect example of this, averaging an annualised loss of 5.2%.
To avoid falling into these traps, investors need to be informed to make smart decisions. Let’s look again at BT. The investment thesis back in 2014 was a play on the fibre optic rollout across the UK, as well as profiting from 4G and eventually 5G.
This sounded foolproof, given that almost all telecommunications companies are dependent on BT’s infrastructure. And initially, things seemed to be working well, with the share price up 16% in 2015 alone. But things quickly turned sour as the cost of this infrastructure revamp started to emerge.
BT’s debt went through the roof, forcing the business to raise prices while its peers were able to remain competitive. The company lost market share, and its debt burden remains to this day.
To be fair, management has finally started making progress in bringing down leverage. And the rapid rollout of 5G and fibre over the last two years positions the firm to return to growth and generate £3bn in annual free cash flow before 2030. In other words, BT’s story is far from over, but there could be far better opportunities elsewhere, I feel.
This post was originally published on Motley Fool
