UK shares have pushed downwards over the last week, prompted by concerns about US debt ceiling negotiations, higher UK inflation, and a recession in Germany.
While these are concerns for the market, falling share prices also represents opportunity. The opportunity to buy at lower prices and secure larger dividend yields.
And that’s useful, because today I’m looking at how much money I’d need to invest in UK stocks to stop working and live off dividends alone.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
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Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
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Obviously, it’s going to be a lot of money. But the big questions is how we get there.
How it works
This strategy revolves around owning a portfolio of dividend stocks that pay enough money throughout the course of the year to live on. In turn, this would allow me to stop working.
Firstly, I’d want to be using an ISA wrapper for my investments. That’s because dividends received on shares within an ISA are tax free. So if I’m able to generate £30,000 a year from stocks in an ISA, I get to keep all of it.
However, if I want to generate £30,000, I’m going to need a lot of money invested in UK stocks to achieve it. Personally, I believe the biggest sustainable dividends achievable at the moment are around 8%.
This involves investing in several companies — to spread risk — that don’t tend to offer much in the way of share price growth, but reward shareholders with sizeable dividends. But this means I’d need £375,000 invested to hopefully achieve £30,000 in dividends.
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Getting there
Very few of us are fortunate enough to have £375,000 sitting in a bank account. To many, that will sound like an insuperable financial target. However, with time and regular contributions, it’s possible to turn a small pot of money into a much larger one.
Using a compound returns strategy, and 8% yields, it’d take 19 years to turn £35,000 into £375,000. This involves reinvesting the dividends every year, and regular contribution — £300 a month, increasing by 5% annually.
The stocks
Whether we’ve already got £375,000, or we’re embarking on our compound returns strategy, the stocks we pick are important.
Big yields are always attractive, but some are warning signs. So it pays to do our research. The dividend coverage ratio is a great place to start. This tells us how many times a company can pay dividends from its net income.
A ratio above two suggests the dividend is healthy. But some companies will have strong cash generation, but lower coverage ratios — I back several of these companies too.
Legal & General is among my top picks right now. In fact, I recently topped up as the share price fell last week. The insurance giant now offers a dividend yield around 8.6%. That makes it one of the strongest on the FTSE 100. Coverage is around 1.8, but cash generation is strong.
