Dividend shares are arguably one of the easiest and most conventional methods for generating a chunky passive income. By buying shares in terrific, high-quality companies, investors are able to watch money magically appear in their bank accounts whenever they pay dividends. And in the long run, it’s possible to earn an extra five-figure income without having to lift a finger.
Eyes on the target
Having an extra 10 grand in the bank each year from passive income is an ambitious goal. And unless an individual is fortunate enough to have an enormous pile of cash saved, it’s one that’s going to take a few years to achieve. Nevertheless, despite appearances, it’s a milestone that even those with only £500 to spare each month can hit.
Right now, the FTSE 100 offers investors a fairly average yield of 3.5%. And simply investing in a low-cost index fund can immediately unlock this stream of passive income while also automating the portfolio management process. The problem is that at this level of payout, a portfolio would need to be worth just over £285,000 to generate £10,000 of passive income each year.
Investors can still reach this target. Investing £500 each month at the market average rate of 8% would eventually build a nest egg of this size within just under 20 years. However, by being more selective and picking individual stocks, it’s possible to reach a yield of 5% without needing to take on too much extra risk.
Not only does this reduce the portfolio value requirement to £200,000 for the same passive income, but the extra 1.5% would reduce the timeline by 25% to 15 years.
Finding 5%-yielding dividend shares
Looking across the FTSE 350, there are plenty of 5%-yielding opportunities to pick from. The challenge is identifying which companies can actually maintain and preferably grow their payouts over the long term. Let’s take a look at one of the UK’s largest companies – Lloyds Banking Group (LSE:LLOY).
Right now, the bank’s shares offer exactly 5% in shareholder payouts. And given its size, the company certainly seems like a safe place to invest.
Even after the recent interest rate cuts, the group’s net interest margin is finally looking attractive after a decade of being exceptionally thin. And since it’s seemingly unlikely for interest rates to fall back to nearly zero anytime soon, Lloyds’ boosted profitability looks like it’s here to stay.
This certainly sounds like a terrific spot to park some money. Yet, even the biggest businesses aren’t immune to disruption. In the case of Lloyds, the bank’s performance is ultimately tied to the state of the British economy. While this has improved drastically compared to a few years ago, the UK has a reputation for low growth. That means less demand for Lloyds’ financial products and limited dividend growth potential.
Therefore, while its current dividend yield might look good today, it may not stay that way in the future versus other dividend shares that investors can pick from right now.
This post was originally published on Motley Fool
