Although buying individual stocks is central to my investing strategy, I believe there are merits to passive investing. If I wanted to gain broad exposure to the UK’s leading large-cap companies, investing in a FTSE 100 tracker fund would be a great way to achieve this.
Vanguard’s low-cost FTSE 100 UCITS ETF (LSE:VUKE), which mirrors the index’s performance, is a good example of a passive fund I could invest in. Currently, it offers a 4.28% dividend yield and distributions are paid quarterly.
So if I aimed to replace my salary with passive income from the UK lead index, how much would I need to invest in Vanguard’s exchange-traded fund (ETF)? Let’s crunch the numbers.
The FTSE 100 is a global leader among stock market indexes for dividends. That’s because it has a high concentration of well-established businesses with long track records of profitability.
Insurers, miners, housebuilders, telecoms giants, tobacco companies and other firms form the ranks of London’s leading benchmark. There’s a notable absence of more speculative growth stocks, such as tech companies.
To illustrate the point, here are the top 10 yielding Footsie shares at present.
|FTSE 100 stock
|Phoenix Group Holdings
|British American Tobacco
|Legal & General
By investing in Vanguard’s FTSE 100 UCITS ETF, I’d gain exposure to these companies as well as the remaining 90 that complete the index.
Imagine I wanted to target £30,000 in annual passive income. As I write, the ETF currently trades for £33.49 per share.
At today’s yield, that means I’d need to buy 20,930 shares for a total price of £700,945.70.
Passive vs active investing
That brings me to the relative merits of passive investing against active investing. Although the Footsie has an impressive yield compared to other indexes, it’s possible to beat this by pursuing a more active approach.
If my portfolio had greater exposure to high-yield dividend stocks like those in the table above, I might earn more passive income for each pound I invested. For instance, if I secured a 6% yield on my stocks, I’d only need to have £500,000 invested to generate £30k a year — that’s over £200k less than I’d need by passively following the FTSE 100!
By the same token, if I made good stock picks with potential for big share price gains, I could secure higher returns. For example, one FTSE 100 stock that has outperformed the index over five years is pharmaceutical titan AstraZeneca, as the chart below demonstrates.
That said, there are higher risks involved when it comes to buying individual stocks. Dividends can be cut or suspended, especially if yields reach unsustainable levels. Similarly, just because stocks like AstraZeneca have outperformed over recent years, there’s no guarantee they will continue to do so.
Passive investing mitigates these risks to some extent via diversification. By gaining exposure to more stocks, I’m less reliant on any single company for passive income, or capital appreciation.
I don’t think an ‘all or nothing’ approach is required. My own portfolio contains a mix of passive tracker funds and individual stocks, in line with my risk appetite.