As a value investor, I like buying shares at discount prices. Also, I prefer stocks that pay decent dividends, which make up almost all of my passive income.
What is passive income?
Passive income is money that doesn’t come from paid work. This unearned income includes savings interest, bond coupons (that is, interest), property income, pensions, and so on.
I love passive income because it works around the clock 24/7, 365 days a year. One day, my goal is to have enough unearned income to retire comfortably.
My favourite form of income
As a long-term investor in shares, most of my passive income comes from share dividends — regular cash distributions paid by companies to shareholders.
However, future dividends aren’t guaranteed and companies can cut or cancel them without warning. During the 2020-21 Covid-19 crisis, dozens of UK firms withdrew or reduced their cash payouts.
Only a small proportion of UK-listed companies actually pay out dividends. Then again, all but a few member companies of the blue-chip FTSE 100 index regularly pay out surplus cash to their owners.
One recent report estimated that total FTSE 100 dividends would jump 11% this year to £84.8bn. This torrent of cash is just waiting to be snapped up by shareholders, both existing and new.
This mini-portfolio pays 8.4% a year
Nowadays, top UK savings accounts pay interest of around 3.5% to 4.5% a year (before tax). That money is almost completely safe, but I don’t know anyone who got rich simply by sticking with cash deposits.
On the other hand, company shares are much riskier. Still, I’m happy to take on this risk in order to earn higher long-term returns. Indeed, long experience has taught me that a balanced portfolio of shares generates rising cash dividends over decades.
For example, this table lists five of the highest-yielding FTSE 100 shares today:
| Company | Business | Market value | Share price | One-year change | Five-year change | Dividend yield |
| M&G | Asset manager | £4.8bn | 201.5p | -5.0% | -10.5% | 9.7% |
| Phoenix Group Holdings | Insurance | £5.8bn | 582.2p | -2.5% | -17.7% | 8.7% |
| Vodafone Group | Telecoms | £25.5bn | 94.2p | -25.2% | -55.3% | 8.2% |
| Legal & General Group | Asset manager | £15.1bn | 253.1p | +3.2% | -5.7% | 7.7% |
| British American Tobacco | Tobacco | £67.1bn | 3,001p | -9.9% | -25.6% | 7.5% |
These five shares offer dividend yields ranging from 7.5% to 9.7% a year. The average cash yield across all five Footsie stocks is a market-beating 8.4% a year. By contrast, the wider FTSE 100’s dividend yield is around 3.7% a year.
This isn’t a proper portfolio
For the record, my wife and I already own shares in Legal & General and Vodafone in our family portfolio. My wife avoids tobacco stocks, so British American Tobacco won’t ever be one of our holdings.
However, I’d willingly buy shares in M&G and Phoenix Group Holdings to add to our existing shareholdings. I’d do this purely for their passive income. Like I said, I’m a sucker for high-yielding stocks. Alas, I can’t buy any stocks just yet, because I’m low on cash.
Crucially, it’s important to note that a portfolio consisting of just five shares would be highly concentrated and unbalanced. Personally, I’d aim to have at least 20 to 25 stocks in a well-balanced portfolio.
Lastly, buying high-yielding stocks is by no means guaranteed to produce superior returns. But it’s worked for me since the 1980s!
