The idea of passive income is what first attracted me to investing. But what put me off was the impression that I needed a lot of money. It felt like there was no point in starting unless I had at least £10,000.
Now I realise the absurdity of that thought process. I could have started at any time with as little as £100 a month (or less). The key factor was time, not money. The sooner I began, the better. Looking back, I now see how much I could have been earning had I just put £100 a month into dividend stocks.
But which stocks are best?
Knowing what I know now, the first thing I’d have looked at was the dividend yields of popular FTSE 100 shares.
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The table below shows the top five companies with the highest yields currently.
My initial reaction would be to invest in Phoenix Group, the highest-paying dividend stock. But will it stay that way?
Building passive income takes time, so I need to think long-term. Looking at its history, the company’s been paying a dividend since 2010 but, for much of that time, the yield was between 6% and 7%.
The volatility makes it unreliable.
Next on the list, Vodafone, recently cut its dividend so it won’t be 10.34% for much longer. Until recently, British American Tobacco was only paying 6% and before 2018, it was only 3%. And M&G has only been paying a dividend for four years.
Which takes me to Legal & General (LSE: LGEN). L&G’s been paying a consistent and reliable dividend for 24 years. In that time, it’s steadily risen from 3% to 8%. When it comes to passive income, consistency and reliability are the key factors I’m looking for.
Legal & General Group Dividend Yield History
Yes, it’s had ups and downs so it might dip back below 7% for short periods. But in the long term, I’d expect it to keep growing.
Of course, there are some risks. Profit margins are down to 3.6% from 6.4% last year, so performance is slipping. I also see that earnings per share (EPS) is only 7p, while dividends are currently 20p. That makes the payout ratio well over 200%, meaning dividends could be cut if earnings don’t improve soon. And with a price-to-earnings (P/E) ratio more than double the industry average, the share price could be overvalued.
But it isn’t a growth share so that’s not unusual. The share price is only up 176% in the past 20 years. This equates to annualised returns of 5.22%, which is a fairly acceptable rate for an income share.
Taking these figures into account and averaging a 2% annual yield increase, I can calculate my potential passive income. By reinvesting the dividends and compounding the returns over 10 years, my pot could grow to £23,642, paying annual dividends of £1,953.
If I continued investing £100 a month for a further 10 years, the total could grow to around £132,149, paying annual dividends of £13,700. That’s a decent £1,141 a month in passive income.
Of course, these are just projections based on the past performance of one stock. Ideally, I would diversify my investment over several reliable dividend stocks to safeguard against a single failure.
