Being somewhat lazy at heart, I prefer passive income to earnings from working. Passive income is unearned, so it involves little time and effort on my part. Also, my favourite sort of unearned income is dividends from UK shares. These are regular cash payments paid to shareholders by companies.
Building passive income from dividends
With global interest rates still close to record lows, I don’t rely on savings interest to build wealth. That’s because the best UK savings rates are around 1.8% a year. And I don’t know anyone who got rich making returns below 2% a year.
After 35 years as an investor, I’ve found UK dividend shares to be my favourite form of passive income. But here’s the big problem: most London-listed stocks don’t pay dividends. Even the blue-chip FTSE 100 index contains a handful of shares that don’t. Also, these cash payouts are not guaranteed, so they can be cut or cancelled at any time.
I’ve built a new portfolio of 10 dividend stocks
For the record, the FTSE 100 has a cash yield of below 4% a year. I prefer to buy shares that offer dividend yields of a multiple of this figure. By buying so-called high-yielding stocks, I can generate higher passive income that, over time, could help to boost my investment returns.
Recently, I build a mini-portfolio of 10 new shares that offer dividend yields ranging from 2.5% to 13.5% a year. The average cash yield across these 10 stocks is around 7.5% a year, which I will reinvest into more shares. Let’s say that these stocks increase in value by another 2.5% a year, delivering a total return to me of 10% a year, ongoing.
Investing £25 a week over the long term
How large a pot could I expect to make by investing, say, £25 a week — which I’ll conveniently round to £100 a month — over the long term? Here are the numbers:
| Period | Amount invested | Pot value |
| 10 years | £12,000 | £19,125 |
| 20 years | £24,000 | £68,730 |
| 30 years | £36,000 | £197,393 |
| 40 years | £48,000 | £531,111 |
What this table shows is the incredible power of long-term investing. For example, saving £100 a month for 10 years produced a gain of £7,125 on top of my original £12,000 invested. But over four decades, this figure skyrockets to a gain of £483,111 on £48,000 saved. Wow.
For ease of calculation, I’ll round down that 40-year pot to half a million pounds. Withdrawing 4% of this sum each year would give me a lifetime income of £20,000 a year — and all from a starting point of just £25 a week. What’s more, I can keep my other 96% invested each year (after year) to generate more passive income and capital growth in future. This is the wonder of long-term investing for a brighter future!
Spreading risk and dodging tax
To spread my risk, I’d invest in at least 20 dividend-paying shares, so that I risk no more than 5% of my pot on any one share. Likewise, I’d use low-cost share-dealing services to minimise my investment expenses. Also, I’d save inside a Stocks & Shares ISA to avoid tax on my delicious dividends and capital gains. And then I’d kick back and enjoy life, which is what I strive to do today…
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.
