The State Pension isn’t enough to secure a fun-packed retirement, and I’ll supplement mine by building a passive income from shares.
My chosen way of doing this is to invest in dividend-paying FTSE 100 stocks, as they offer some of the most generous shareholder payouts in the world. Today, the index yields a steady income of 3.93% a year. That should rise over time, as companies listed on the index look to increase their dividends as profits rise.
This is how I’m building passive income
Some FTSE 100 stocks would give me a far higher passive income than that. Mining giant Anglo American currently yields 9.07% a year, while insurer Aviva offers income of 8.73% and Barratt Developments yields 8.81%. All three are dividend aristocrats, and I haven’t even got past the Bs.
The FTSE 100 is fertile ground for investors like me, who want the highest possible passive income in retirement.
These yields are not guaranteed though. As we saw in the financial crisis and again during the Covid pandemic, companies can cut them in times of trouble. Yet management will only do that in extremis, because investors don’t like it.
Let’s say I invested in a spread of FTSE 100 stocks, so I bagged that average yield of 3.93% (even though I reckon I could do better).
Now assume I wanted to generate £1,000 a month of passive income, which adds up to £12,000 a year. To achieve that, I would need to build an investment portfolio of £305,344. So that’s the capital target I have to aim for.
Of course, if I drew my passive income from a pool of FTSE 100 offering higher yields, I could generate the same passive income from a smaller portfolio. If my stock picks yielded on average 6% a year, I could generate £1,000 a month from a portfolio of just £200,000.
I think that target is achievable, even for newbie investors. Take someone who is 35 today, and plans to retire at 68. They still have 33 years to build the portfolio they need.
Tax-free inside a Stocks and Shares ISA
If they invested £200 a month in a Stocks and Shares ISA, and their investments grew by 7% a year, on average, they would have £305,421 by age 68. That’s enough to generate a decent passive income, entirely free of tax.
This highlights the importance of investing as early as possible. The first £1 invested is the most important, because it has longest to compound and grow. Naturally, there is no guarantee that my portfolio would grow at an average rate of 7% a year, although that is roughly what the FTSE 100 has delivered over the decades.
On the other hand, it could grow at an even faster rate, giving me an even larger pool of money to generate my passive income. Even if I don’t hit that target, I will still enjoy a more comfortable retirement then if I relied solely on the State Pension.