As I recover from a heavy Christmas dinner, I’m pondering my best passive income ideas for the New Year.
I can think of dozens of solutions, but one method sticks out as my preferred option for 2023. It’s dividend shares.
Some companies pay a portion of their profits to shareholders in the form of dividends. These regular payments are often paid quarterly. For some FTSE 100 shares, dividends form a large part of total stock market returns.
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Currently, the average Footsie dividend yield is 3.8%. But many shares pay much more. When I’m looking for income shares for my Stocks and Shares ISA, I tend to prefer those that yield between 6% and 10%.
Passive income plan
If I had £100 a month to invest in a passive income plan, here’s what I’d do. First, I’d look at some criteria to narrow down my options.
By sorting a list of FTSE 100 shares by yield, one thing I notice is that housebuilder Persimmon yields a whopping 19%.
Now, a word of warning. This looks like an outlier to me. I’d be wary of considerably large dividends. It’s often a red flag that could warn of an upcoming dividend cut.
As these profit payments aren’t guaranteed, companies can decide to suspend or reduce the amount. This could occur if there is an upcoming risk to their earnings.
Reliable dividends
As such, the size of a company’s dividend yield isn’t the only factor to consider. I’d also look at its reliability. One way to do this is to see how many years a company has paid dividends.
I prefer dividend shares that have consistently made payments over many years, and sometimes even decades. There’s no guarantee that they will continue to do so, but it can give an indication to its past behaviour.
Next, I’d look at whether a company can afford to pay its anticipated dividend from its earnings. One measure to look at for this is dividend cover. I’d prefer a figure greater than 1.5 to be comfortably satisfied that the payment is affordable.
Company research
Once I’ve filtered my list, I carry out some due diligence. This involves researching what the companies do, and if I think they will continue to thrive over many years.
As I’m focusing on reliable passive income, I’m less concerned about capital growth. That means my shortlist is unlikely to include any fast-growing penny stocks for instance.
Over time, my preferred list of dividend shares might change. But right now, I’d buy Legal and General Group, Imperial Brands, Aviva, British American Tobacco, and Sainsbury (J).
Digesting dividends
By investing £100 a month into these five shares, I’d expect to receive 7% a year in income. But as mentioned, it’s not just about the yield. With this selection of shares, I’d also be getting a whopping 29 years of back-to-back dividend history.
It means I could reliably achieve a passive income of around £84 in one year. It might not sound like much now, but over time I could invest a bit more every month. And eventually, I’d expect my dividends to multiply.
