Dividend shares can be a great way to produce passive income. I own several myself and each provide a reasonable semi-regular income. The UK is home to some excellent dividend shares, in my opinion. In particular, the FTSE 100 includes several companies that offer dividend yields of over 5%.
If I invested £10,000 in a selection of these shares in 2022, I could end the year with an extra £500 of dividends. Passive income from shares isn’t just about the dividend yield though. Over time, I’d hope for the value of the shares to grow too. If my selection of shares can grow in value by just 5% a year, I’d be looking at 10% in total, including dividends. That’s around the long run total return for the FTSE All-Share index looking back over the past 35 years.
The power of reinvesting dividends
To gain an even larger passive income, I’d want to start with a larger sum of money. But that’s not always possible. Alternatively, I’d try to reinvest my dividends over time to grow my pot. Reinvesting dividends is a powerful way of making my money work harder. It works by using every dividend payment to automatically purchase new shares. Over time, I’d build up plenty of shares purchased just from dividends and each of these shares would in turn pay dividends, thus amplifying the effect.
Here’s an example. Let’s say I invest £10,000 in quality shares that yield 5% and the dividends grow at 5% per year. Let’s also assume the share price climbs by 5% per year and I’m investing for 25 years.
Using these assumptions, I calculate that my total pot without reinvesting dividends would total almost £59,000. Over 25 years, it should have paid out around £25,000 in dividends. This doesn’t sound too bad to me. But now consider this. By reinvesting my dividends over the same timeframe, I’d potentially own a total pot worth almost £115,000. That’s almost double. Also, it would have paid around £54,000 in dividends over that time.
That’s a considerable difference and it shows I could achieve a much greater passive income if I invest for a long period of time and reinvest my dividends.
Top 5 passive income shares
But what if I don’t have that long and want a passive income in 2022? I’d look for the best high-yielding shares right now. My list of ‘no-brainer’ dividend shares I’d consider includes Ferrexpo, Evraz, Rio Tinto, BHP group and Persimmon.
On average, these five shares currently yield around 8%. That’s far above the average FTSE 100 dividend yield of 3.5%. That sounds great, but I wouldn’t just look at the dividend yield in isolation. There are several other factors I’d want to consider. For instance, are they regular dividend payers? Yes, they are. On average, they’ve been paying regular dividends for 12 years. I prefer dividends to be affordable too. And that appears to be the case here. On average, dividends are well-covered by earnings.
A word of warning, however. Earnings can fall and occasionally companies can decide to suspend or cut dividends. Also, many of the shares in this group operate in the mining sector. This concentration of stocks could be a risk if the whole sector comes under pressure.
Overall, I reckon the pros outweighs the cons though, and I’d be happy to consider these shares for passive income for my portfolio in 2022.
