Buying shares in companies that pay regular dividends has long been a popular strategy for UK residents seeking to build wealth and generate passive income. I think one of the most effective ways to do this is through a Stocks and Shares ISA — an investment account that allows UK residents to invest up to £20,000 per year tax-free.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
It’s no secret that I’m a huge fan of investing in dividend shares, but most of my friends prefer to focus on growth shares. Why? Some believe a company’s focus on rapid growth could deliver greater returns in a shorter period.
While that may be true, I’m more focused on the long game.
Why I think dividends are good for long-term wealth
One of the key benefits of investing in dividend stocks is the stable income they can offer. While dividends aren’t guaranteed, I find the returns are usually more reliable. This becomes even more evident when considering the power of compounding returns. When dividends are reinvested back into the same stocks, they can generate additional income, which in turn can be reinvested, creating a snowball effect. Over time, this compounding can lead to significant wealth accumulation.
For example, consider a £10,000 investment in a portfolio of dividend-paying companies. Assuming an average annual return of 9% (including dividends), the investment could grow to approximately £60,000 after 20 years. This would pay around £5,000 per year in dividends. After retirement, I could withdraw £6,000 per year for 10 years in addition to the dividends.
Naturally, investing more money for even longer could compound the returns exponentially, although I have to remember that gains aren’t guaranteed.
One of my favourites
A dividend-payer I like the chances of right now is insurance firm Phoenix Group (LSE: PHNX). It’s a big player in the UK insurance game, operating SunLife and Standard Life, among other subsidiaries. The UK’s ageing population presents a growing demand for retirement savings and income solutions, which could help boost its profits.
But it’s not all plain sailing.
If the economy hits rough waters again, increased claims and reduced investment returns could hurt the group’s financial performance. Not only that, the insurance industry is heavily legislated. Regulatory changes could impact Phoenix Group’s operations and profitability.
Performance-wise, things are a bit disappointing. It’s down 25% in the past five years. However, a recent growth spurt has helped it gain 20% in the past year. If the improving economy can help it keep up that performance, it could become one of my top income earners in 2025.
It’s also in a relatively good financial position, with £9.6bn in cash reserves and only £3.7bn in debt. By comparison, fellow insurer Legal & General has £28.3bn in debt and only £15.8bn in cash. Although it reported losses in its latest earnings report, it has a low price-to-sales (P/S) ratio of 0.2. This indicates its price is cheap compared to its revenue.
With a 10% yield and a history of paying consistent dividends, I’ve found it a very attractive option for my income-focused portfolio. Since 2010, yearly dividends have increased from 31.8p per share to 56.5p, representing 2.78% growth per year on average.
This post was originally published on Motley Fool
