Key points
- Passive income can be achieved through dividend investing
- High yields aren’t always sustainable
- I’m building a diversified portfolio of UK-based companies
Passive income is money earned while we aren’t working. Building a consistent stream isn’t easy and takes years of dedication. But it’s not impossible. I could start a business, or rent out property. But neither of those options will start generating passive income right away and they also involve some extra work. The best way I know how to achieve my aim is with dividend investing.
Dividend investing
Dividends are payments made to shareholders from a company’s profits. These payments can be issued once, twice, or even four times a year, and they’re generally indicative of a company’s profitability. Dividend investing is a method by which investors construct a portfolio of dependable firms that provide a consistent dividend that can then be reinvested. This technique is quite popular in the UK, and we’ve witnessed record-high dividend yields in recent years. Some have even gone as high as 13% or 15% of a share’s value!
Yields and sustainability
These high rates, however, are typically unsustainable in the long run. For example, in 2019, mining firm Evraz paid 53p per share, representing a staggering 13.39% of the share price. But the company only paid 42p in 2017 and nothing in 2015 or 2016.
The average payout of big listed corporations in the UK is roughly 4%. This year BAE Systems and Unilever are scheduled to allocate 4.05% and 3.97%, respectively. But it’s important to understand that no firm is required to raise, retain, or even pay a dividend. The importance of consistency can’t be overstated.
Portfolio size
I figure I’ll need a total pool of £125,000 to meet my monthly objective of £400 in passive income. 4% of £125,000 is £5,000. That’s £416.60 if I split it over 12 months.
While I don’t have that kind of cash on hand, if I set aside £350 every month, I’ll be able to attain that magical figure in roughly 30 years.
Granted, 30 years is a long time, but if I start investing that money immediately, compound interest will help me get there sooner. Now all I have to do is pick a few businesses in which to invest.
My preferred companies
While the goal is to seek out secure organisations I can trust, I believe it’s worthwhile to take a few chances in order to accelerate my pot’s growth. I’ve already written about Imperial Brands. Since 2002, the tobacco firm has issued a substantial dividend to its stockholders at least twice a year. Today’s yield is a fantastic 8%.
I’m not overly concerned if it decides to reduce its dividend payout because my plan’s benchmark is 4% over 30 years. Anything over that is a bonus. However, I believe it’s critical that I don’t rely only on this technique and instead diversify my portfolio with smaller-yield firms.
Lloyds Bank pays a dividend of roughly 2.37%, lower than my target return, but banks are generally stable businesses. Finally, I’d go with Unilever as it’s a huge, prosperous firm that now pays almost 4%.
None of this is guaranteed though. Investing always entails risk. The essential thing for me to do in that case is to diversify my portfolio so that I can weather any storms and build towards my passive income dream.
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James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.
