FTSE 100 income stocks: how I’m aiming to make £10k a year from dividends

Jonathan Smith runs the numbers and shows how it’s possible for him to generate a five-figure sum annually from FTSE 100 income stocks.

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The FTSE 100 currently offers an average dividend yield of 3.03%. So in general, FTSE 100 income stocks can offer me a better place to generate money than other alternatives (such as a Cash ISA). Of course, not all FTSE 100 stocks currently pay out a dividend. Also, depending on the alternative, I might be able to generate a higher yield by taking on more risk. For me, I like the risk/reward ratio of getting income from stocks, and am aiming to get to £10k a year from this investment strategy.

Getting income from FTSE 100 stocks

Before I get to the £10k specifically, I think it’s important to to look at the metrics behind getting income from FTSE 100 stocks.

I want to ensure that the dividends I receive are spaced out. Getting a lump sum of £10k once a year is handy, but for my cash flows needs I’d much prefer to receive payments on a quarterly (or even monthly) basis. I can achieve this by holding a portfolio of FTSE 100 income stocks, instead of just one or two.

In this way, companies will pay dividends at different points during the year. By owning enough companies, I can ensure that my payment stream is regular, which fits in with my aim a lot better.

Another metric that’s important to me is to ensure I don’t have to buy and sell FTSE 100 income stocks regularly due to dividend cuts. This would not only increase my transaction fees, but also create more work for me. I’d have to find another stock to replace the one that has cut the dividend.

What can I do to prevent this? Well there isn’t a perfect solution, as some issues pop up unexpectedly. One point I do like doing is checking the dividend cover of a company. This shows me how much its earnings cover the dividend. It’s a simple ratio but a powerful one. For example, if I see the dividend cover is below one (that is, its earnings don’t cover its dividend), then I’ll probably stay away from it, even if the yield is very attractive!

How can I make £10k a year?

Let’s now turn to the numbers to get to £10k a year from FTSE 100 income stocks. I need to assume a dividend yield for this. I’m going to use one example with the average yield of circa 3%, and another one with a higher yield of 6%. This higher yield can be obtained by being selective in the stocks I choose to buy.

If I wanted to get this passive income starting right away, I’d need to invest either £333k (3%) or £166k (6%). Both are sizeable lump sums to put to work, so I need another option.

By putting away £1,000 a month and reinvesting the dividends I initially receive, it would take me pretty much bang on 20 years to reach my target. This is with the 3%-yielding stocks. With 6%, the timeframe needed would decrease by a decade! This shows the power of a higher yield over time.

Of course, I could also lose my money and there’s no denying that stocks carry greater risk alongside their rewards. But overall, I think FTSE 100 income stocks can help me on the way to a healthy and sustainable stream of dividends.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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