The idea of generating passive income obviously appeals to most people. That’s why there are a fair few ways of achieving it these days.
One tried-and-tested method is to buy company shares that pay dividends. In the UK, this can easily be done – tax-free – inside a Stocks and Shares ISA.
To demonstrate, let’s assume someone wants to aim for seven grand a year in passive income. How much would they need to achieve this? Let’s find out.
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Taking a long-term view
The level of income generated will ultimately depend on the yield of the investor’s portfolio. I have four dividend stocks that yield above 5%. The average for this quartet’s currently 7.4%.
| Dividend yield* | |
| Legal & General | 8.8% |
| British American Tobacco | 7.8% |
| Aviva | 7% |
| HSBC | 5.9% |
However, I have a dozen other stocks that yield 2-4%, meaning the overall portfolio yield’s lower. Based on a 6% yield then, an investor would need just under £117,000 to generate the required £7k a year.
While that sum might initially seem unachievable, it can be worked towards with modest regular outlays. For example, investing £500 a month and achieving a 7% return would reach that figure after 12.5 years. £650 a month with an 8% return? That comes down to just 10 years.
Now, it’s worth stating that returns are impossible to predict accurately. But 7-8%’s roughly in line with the long-term average of UK stocks. So it’s definitely achievable.
Ultra-high yield
Turning again to Legal & General (LSE: LGEN), the highest-yielding stock above, I think it’s worth considering as part of a diversified income portfolio.
The FTSE 100 company has a long history and strong brand in insurance and pensions markets. At the end of 2024, it managed over £1trn in assets!
The group’s done a tremendous job of increasing payouts over a long period. However, analysts are forecasting a 2% rise in the payout for 2025 and 2026. That’s lower than the 5% increases that shareholders have been receiving on average over the past few years.
But another way that companies can reward shareholders is through share buybacks. These tend to boost financial metrics like earnings per share (EPS), as they are divided among fewer shares, meaning each one gets a bigger slice of the earnings.
The company completed a £200m buyback in November, but now expects to return an additional £1bn through buybacks following the £1.8bn sale of its US protection business. This sale to Japan’s Meiji Yasuda is expected to be completed towards the end of 2025.
Another possibility is that this sizeable buyback could give the share price a boost, though that isn’t guaranteed.
As for risks, demand for Legal & General’s products – and therefore profits – could decline if economic conditions deteriorate. Additionally, its large asset management division’s exposed to market downturns, making earnings volatile.
Longer term though, I think the financial services group will continue pumping out high-yield dividends. It should also have plenty of business opportunities as the UK’s population continues to rapidly age.
A nice spread of stocks
Finally, it’s worth remembering that no individual dividend’s guaranteed. So it’s necessary to construct a diversified portfolio of high-quality passive income stocks.
As mentioned, my portfolio has over a dozen shares that distribute dividends. This mix cushions the blow if any one doesn’t pay out.
This post was originally published on Motley Fool
