Investing in FTSE 100 shares can be a great way to make a second income. The long-term dividend yield on these blue-chip shares sits at around 4%. This is far above what the average UK savings rate has been in recent decades.
And it has the potential to eventually provide me with a healthy monthly income. Here’s how I could turn a £7,000 lump sum investment into a £1,253 passive income with Footsie shares.
Investing in dividend shares
Since the mid-1980s, FTSE 100 investors have — on average — enjoyed a 4% yield through dividend payments, and a further 4% through capital gains.
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If this trend continues, someone who invests £7,000 in an index tracker would receive £280 a year in dividend income. That’s a decent amount, but it’s hardly spectacular. It’s why I think investing in individual stocks with higher dividend yields could be a better way to go.
Let’s say that I decided to buy shares in a company that yields 6%. If dividend forecasts proved correct, that £7k would instead provide a passive income stream of £420.
A £1,253 passive income
That’s £140 more than I could have made with a FTSE 100 tracker. And thanks to the miracle of compounding — where an individual earns money on reinvested dividends as well as on their initial investment — this difference could really supercharge my wealth over the long haul.
With a 6% dividend yield and 4% capital gains, a £7,000 initial investment could swell to £375,905 after 40 years. And that’s assuming I only reinvest my dividends and make no further investments from my wage packet.
If I then drew down 4% of this amount each year, I would have a yearly second income of £15,036. That works out to £1,253 a month.
A top stock
It’s important to remember that dividends are never, ever guaranteed. As we saw more recently during the pandemic, shareholder payouts can collapse across the FTSE index in very short notice.
But there are plenty of blue-chip stocks out there whose defensive operations, leading market positions, and robust balance sheets have underpinned impressive dividend records in recent times. Utilities business National Grid, life insurer Aviva, and banking stock Lloyds are just a few.
I believe HSBC (LSE:HSBA) could be a good choice for dividend income today. Its forward dividend yield currently sits at 8%, it has a strong capital base (with a CET1 ratio of 14.8%), and the interest it receives on loans and credit cards provides a steady source of revenue for it to redistribute.
I believe dividends could rise strongly in the coming decades, too. It is well placed to capitalise on the retail and investment banking boom currently being witnessed across Asia.
Economic turbulence in its critical Chinese marketplace threatens profits in the near term. This in turn has driven its valuation to rock-bottom levels; today it trades on a forward price-to-earnings (P/E) ratio of 6.7 times, well below its historical average of 13 times.
This makes HSBC shares even more attractive in my book. If I were building a high-yield passive income portfolio today, I’d definitely add the banking giant to it.
