UK shares can be an excellent hunting ground for regular passive income. Many FTSE shares offer dividend yields over 4%. In fact, almost a third of FTSE 100 shares do.
But dividends are only part of the equation. In addition, the underlying companies tend to grow over time. As an investor, building my pot is just as important as withdrawing regular income.
But just how big pot am I talking about? Let’s break it down.
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Crunching the numbers
The rule of thumb for withdrawing money suggests that investors can take out 4% of their portfolio balance to avoid running out of money.
That means to earn £3,000 of passive income every month, investors would need savings of £900k.
I imagine most readers won’t have such a sum available right now. And if it sounds like a lot, let’s break it down even further.
I assume investors can earn 8% a year on their investments. I’ve picked this figure because 8%-10% is the long-term average gain for shares, although that isn’t guaranteed.
This means to build a £900k pot, I calculate that one should be able to do so by saving and investing £12,500 annually over 20 years. Or by starting earlier one could invest £8,000 every year for 30 years.
Investing for growth
Deciding what to invest in can often seem like a minefield. With seemingly thousands of potential options, it could be confusing.
For a simple approach, I think investors should consider splitting their investment strategy into two parts. First, the aim is to grow the pot. Second, I’d target a regular passive income.
For part one, I suggest a US-focused exchange traded fund. My low-cost preference is the Vanguard S&P 500 ETF (LSE:VUSA). With an ongoing charge of just 0.07% it’s one of the cheapest around.
US stocks comprise of many of the world’s growing technology companies. And their success is likely to continue in my opinion.
What I’d buy for passive income
For part two, when an investor is ready to start withdrawing a passive income, I’d suggest considering a dividend-focused fund. My top pick is City of London Investment Trust (LSE:CTY). It currently offers a 4.7% dividend yield. It also holds many household names that include HSBC, Shell and Unilever.
One of the most impressive factors about this fund is its dividend history. It has been distributing dividends to shareholders for a whopping 58 years back-to-back. Not only that. It has raised it every year too. That’s impressive.
While dividends aren’t guaranteed and companies can cut them at any time, City of London’s track record shows its experience in managing over time.
Right now, it trades at a 2.7% discount to their underlying investments. Although a discount can mean better value, it’s not always the case. It could also mean that its prospects aren’t so strong. That’s why I’d take investment trust discounts with a pinch of salt.
Overall, I’m optimistic my two-part strategy could be a recipe for a successful second income.
