Although retirement is over a decade away for me, I’m still going flat out to generate a passive income from investing in FTSE 100 dividend shares. Now looks like a brilliant time to buy them, as valuations are at a low ebb, while yields are ultra-high.
A little planning never goes amiss, and I’ve drawn up a three-step programme to help max out my passive income potential.
Step one is to find the best dividend income shares and buy them. This is my favourite bit. I love trawling the market for top income stocks, and I love buying them, too, and seeing how they perform.
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Taking it step by step
FTSE 100 performance has been underwhelming lately, but the index looks full of exciting high-income opportunities as a result.
In the last three or four months I’ve bought the following five high-income stocks: Lloyds Banking Group, Taylor Wimpey, Legal & General Group, fund manager M&G and Glencore. My table shows how high their dividend yields are, and how low their price-earnings (P/E) valuations are.
| Glencore | L&G | Lloyds | M&G | Taylor Wimpey | |
| Yield | 7.93% | 8.51% | 5.67% | 9.65% | 7.45% |
| P/E | 4.03 | 5.9 | 5.8 | -3.1 | 6.7 |
This strategy isn’t without risks. Few of these companies have delivered much share price growth lately, which is why they’re cheap. I hope they’ll shake a leg once interest rates fall and markets recover, but there are no guarantees.
These fabulous five deliver an average yield of 7.84%. I’d expect that to rise over time, as management increases those dividends. Even if their share prices don’t grow much, the income should keep ticking over. If I invested the equivalent of a full £20,000 Stocks and Shares ISA allowance in these five, I’d get a blockbuster income of £1,568 in year one.
Step two is to keep buying, keep re-investing. As I’m still working, I won’t draw a penny of those dividends as income today. Instead, I will automatically reinvest them straight back into my holdings.
Invest and reinvest
I’m not done with buying stocks. Far from it. The moment I have more money at my disposal, I’ll top up my income portfolio. I don’t want to miss this year’s Santa rally, if we’re lucky enough to get one.
While the global economy is set to struggle, markets could get a further boost when interest rates start falling next year. I want to be fully invested ahead of that.
Step three is to stick to the plan and give it time. Let’s say my portfolio of five stocks delivers a total return of 7% a year over time (I’m hoping for more, but who knows?).
After 15 years, it should be worth £55,181. If it still yields 7.84% it’ll give me income of £4,326 a year. That’s not a bad return, from an initial £20k investment. Even if inflation has eroded its spending power in today’s terms.
There are huge variables involved in this type of calculation, naturally. However, I won’t be relying on one year’s investment to build a portfolio. I’ve been investing for years and will continue to do so all the way to retirement. That way my passive income could grow to a lot more than £4,326 a year.
