When looking for passive income ideas, there is no shortage of suggestions out there. But to my mind, the simplest strategy is to buy shares in quality FTSE 100 blue chip companies that pay a healthy dividend.
As there are 101 constituents in the index (due to Royal Dutch Shell having two share classes), with a large number of them paying a dividend, then one obvious and extremely cheap way to get exposure to them all is to buy a tracker fund. There is no shortage of providers in this respect. For example, both Vanguard FTSE 100 UCITS ETF or iShares Core FTSE 100 UCITS ETF pay a dividend yield of just under 4%.
Although this seems like a great way of spreading one’s risk, there are two factors to consider:
- As a tracker fund attempts to mimic an index, then a few companies end up dominating it. So, in a FTSE 100 tracker, the 10 largest companies have a weighting of over 40% and not all of them offer fantastic dividend yields
- With inflation currently running at 5.1%, and rising, then one is effectively relying on capital appreciation to make up the shortfall in the dividend yield on your average tracker fund.
Far too many investors discount the effect of inflation on their overall portfolio performance. Psychologists have a name for it: the ‘money illusion’. Without getting technical, studies have proved that so long as the absolute change in performance is positive, we view it as a good thing – even if the real result (after inflation) is actually negative.
I am attempting to beat inflation by picking my own dividend stocks
I am a firm believer that one doesn’t have to be a financial whizz kid or have unusual business insight to be a successful investor. Instead, the largest challenge is keeping one’s emotions in check. A simple strategy that I employ in this regard is to develop a robust framework based around a core investment thesis.
Developing an investing strategy isn’t as hard as it sounds. I don’t have hours to spend every week researching the market, but I have the same basic tool available to me as the pros, namely the internet.
Of course, one could look at the FTSE 100 constituents and buy the highest-yielding ones. But that way I could end up choosing a stock that either doesn’t fit in with my own personal beliefs or whose yield turns out to be unsustainable.
As a value investor, I believe that a narrow group of stocks will be the winners in a world of rising inflation. Elsewhere, I discussed the investment case for BP and Shell. Their dividend yield may not be the best but they have potential upside both as a capital and income investment. And as the world transitions away from fossil fuels, I would rather be invested in companies that have both the financial and intellectual clout to capitalise in the new green economy than riskier smaller ventures.
Another group of stocks I believe to be fantastic passive income generators in today’s environment are precious metal miners. Polymetal, a top-ten world gold producer, offers an impressive 8% yield. Recently, its share price has been trending downward (as has the sector as a whole) and it is a company that I am definitely interested in building a position in.
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Andrew Mackie owns shares in BP and Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
