It’s a great time to build a passive income plan, in my opinion. That’s because the dividend yields of several UK shares looks particularly attractive right now.
Although the FTSE 100 currently yields 4%, there are many individual shares that offer much more. At the top of the leaderboard is housebuilder Persimmon. It currently offers an astonishing 18%. That’s enough to earn £900 a year if I had £5,000 to deploy.
Stable passive income
That sounds great to me at first glance. But I’d be aware that jumbo dividend yields can be a sign of caution. It could indicate a risk of a dividend cut.
For a stable passive income, I’d prefer to pick shares that have more reliable earnings. That’s why I’d look for dividend cover that’s comfortably above one. That would indicate sufficient earnings to be able to afford to pay current dividends.
Top dividend shares
Next, I’d like to own shares that have a long history of distributing dividends to shareholders. Such a supportive policy could help me to earn steady passive income.
When I look at the FTSE 100 today, several shares stand out to me. My top 10 list comprises of: Rio Tinto, Taylor Wimpey, Phoenix Group Holdings, Legal & General, Vodafone, Imperial Brands, Aviva, Land Securities Group, British American Tobacco, and SSE.
If I had £5,000 to put toward a passive income plan, I’d do the following. I’d split my pot equally across these 10 shares. By doing so, I’d own a portfolio of shares that offer an 8% dividend yield. That’s enough to earn a tasty £400 a year.
Looking ahead
In addition, on average, this group has been distributing dividends for 24 back-to-back years. That’s exactly the type of history that gives me confidence for the future.
Bear in mind that dividends are typically paid from earnings, so I’d need to ensure my companies continue to earn enough going forward. I can check this by annually monitoring my stock picks.
One advantage of splitting my £5,000 across multiple shares rather than just buying one is diversification. I’d be spreading my risk to avoid putting all my eggs in one basket.
That way, if one of my shares experiences a shock to its business, my total portfolio is unlikely to suffer significant damage.
The power of reinvesting dividends
Once I’ve bought my shares, I have a choice of what to do with my dividend income at the end of the year. I could just spend it every year and keep my £5,000 invested. Or I could reinvest my dividends.
If I don’t need extra passive income right now, there are great advantages in delaying when I take the income. By reinvesting them every year, I could earn dividends from my dividends.
The additional return might look small to begin with, but over time it can have an extraordinary impact. It’s a bit like a snowball rolling down a hill.
I calculate that if I delay taking passive income for a decade, my annual dividends could double from £400 to more than £800. And instead of a lump sum, if I were to invest £5,000 every year for a decade, I calculate that I could earn over £5,000 in annual dividends thereafter.
