FTSE 100 stocks are a brilliant way to generate a regular monthly income because they pay some of the most generous dividends in the world.
UK blue-chip companies are forecast to generate an average income of 4.2% in the year ahead. Better still, many should also deliver capital growth as their share prices climb.
Investing for the future
It’s possible to generate an even higher income by building a portfolio containing some of the most generous high yielders. That’s what I’ve been doing. In recent weeks I’ve bought insurer Legal & General Group, which currently yields 8.27% a year, and asset manager M&G, which yields a staggering 9.76%.
Buying high-yielding stocks can be risky though. The dividend income stream can be fragile, as companies may struggle to generate sufficient cash flows to maintain them.
Also, yields are calculated by dividing the dividend per share by the share price. If the stock crashes, the yield inevitably rises. This means a high yield is often the sign of a company in trouble.
That doesn’t worry me overly because I buy stocks with a five-to-10-year view. This allows me to buy unloved high yielders with the aim of holding them for the long term while I patiently wait for the share prices to recover.
All the time I reinvest my dividends to increase my stake at the lower price, which puts me in a better position when the recovery finally comes. It works for me but as ever with investing, success is not guaranteed.
By following this strategy, I reckon I could build a passive monthly income of more than £500 a month, by investing just £5 a day. If I stick at it, I could generate an even bigger income. Here’s how my sums add up.
How a little can grow into a lot
Investing £5 a day doesn’t sound that much but it adds up to £1,825 a year. I’d also increase my contribution by 3% a year, to maintain its value in real terms. Investing for retirement is a long-term game, and if I stuck at it for 25 years, I would have £160,265.
This assumes my portfolio grows at 6.89% a year, which is the average annualised return on the FTSE 100 over the last two decades, with dividends reinvested.
By following a financial rule of thumb known as the safe withdrawal rate, I could take 4% as income each year, without the money running out. That would give me income of £6,411 a year from a pot of £160,265. Which works out as £534 a month.
Naturally, there are risks. My portfolio of shares could return less than 6.89% a year. One or two of my stock picks could go bust. The market could crash just before I start withdrawing income. Inflation will erode the value of my income in real terms.
However, by feeding money into a portfolio of a dozen or more FTSE 100 stocks over a 25-year term, I should be able to smooth out most of these risks. If I invest for longer than 25 years or my shares outperform, I could get even more retirement income. Not a bad return from a fiver a day.
