I dream of building a substantial passive income. The idea that some hard work, discipline, and a touch of luck could afford me a dream retirement is pretty amazing.
Lately I’ve been looking at some of the top FTSE 100 stocks and thinking about how I can turn that dream into a reality. The Footsie average dividend yield is 3.5% but some stocks are yielding as much as 10%.
Now, I don’t have oodles of spare cash to invest right now. But I thought I’d see what putting £200 each week into some big name stocks could do for my retirement plans.
Building a £20k passive income
I’ll assume I start with nothing in my portfolio to make things easy. My plan would involve setting aside £200 per week from my paycheck to invest in some top stocks (which I’ll get to later).
In week one, that portfolio has £200 in it. By week 26, six months into my journey, that would be worth £5,325, assuming no capital growth. However, I have assumed a 5% annual dividend yield, which pays me some income every six months.
Assuming I purchased all my shares before the ex-dividend date, that means I’d receive £125 for my first semi-annual dividend payment. Now, the key to my plan is compounding returns. That means I would reinvest this £125 back into my same 5% portfolio to turbo charge my future gains.
After one year, my hypothetical portfolio would be worth £10,783 with £383 in total dividends. After five years, that’s a £59,658 portfolio paying me £2,738 per year.
The magic of compounding really kicks in after a decade. From a £136,025 portfolio in year 10 to £358,919 in year 20, the portfolio value really accelerates with the reinvested 5% dividends.
By year 25, all else being equal, my retirement fund would be a healthy £519,104 with an annual dividend stream of £24,877. Not bad for just £200 a week invested, right?
Putting the plan into action
Of course, this is a simplified example. Share prices will fluctuate and dividend policies will change. However, it does show that building a long-term passive income is achievable with some spare income.
That got me thinking about Footsie stocks offering a 5% dividend yield. I am always wary of dividend traps – shares that have high yields due to share price declines or impending dividend cuts.
However, I think there are some good income stocks out there. BT is yielding 5.5% right now, while NatWest and J Sainsbury (LSE: SBRY) are paying 5% and 4.8%, respectively.
I personally like J Sainsbury. The supermarket game is fiercely competitive with thin margins and near-constant supply chain challenges. However, Sainsbury’s is a market leader with a clear strategy and recent share price gains.
With questions lingering over consumer spending, I prefer non-discretionary segments like groceries over the likes of leisure or retail.
That said, there are no guarantees in life. Sainsbury’s will be challenged by competitors and may still feel the impact of consumer cutbacks. The key to building a long-term passive income is building a diversified portfolio of strong names rather than putting my eggs all in one basket.
This post was originally published on Motley Fool
