Throughout my investing life (starting in 1986/87), my appetite for passive income has grown steadily. Now I’m over 55, I have plans to dramatically increase this unearned income in the years ahead. Here’s how I’ll do this.
Powerful passive income
Unearned income comes in many forms — savings interest from cash deposits, coupons (interest) from government and corporate bonds, rental income from property, private and state pensions, etc.
To be honest, I earn hardly any passive income from the above options. Instead, I make the bulk of my second income from share dividends — regular cash payouts paid by companies to shareholders.
However, these cash distributions have two problems. First, future dividends are not guaranteed, so they can be cut or cancelled without notice. Second, the majority of London-listed stocks don’t pay any dividends.
Boosting my cash dividends
In order to improve the size, safety, and spread of my dividend income, I am reviewing my entire portfolio. Here’s what I plan to do.
First, I’m going to buy more income-producing shares, using a cash windfall arriving shortly. By increasing my exposure to dividend stocks, this should lift my cash flow over time.
Second, I’m going to spread my risk wider by buying into some new companies that pay generous dividends. I’m particularly interested in defensive shares, plus high-yielding stocks in the financial, resources, and energy sectors.
Third, I’m going to reduce the charges I pay in management and other fees. For example, one of my pension pots has fees of at least 1.5% a year. By transferring this to a low-cost index-tracking fund, my charges could plunge to around 0.1% a year. To me, that’s free money forever.
Fourth, I’m going to minimise my tax bill by putting more into tax-free pensions, Stocks and Shares ISAs, etc.
Fifth, after years of zero exposure to bonds, I’m considering adding some to our family portfolio. For example, an ultra-low-risk two-year gilt (UK government bond) pays 5.1% a year in interest. While that’s well below the current UK inflation rate of 8.7% a year, at least it’s something.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The FTSE 100 looks far too cheap to me
As for finding new ‘dividend dynamos’, my preferred hunting ground is the elite FTSE 100 index. That’s because all but a few Footsie stocks pay out dividends.
On a forward-looking basis, the UK’s main market index currently trades on a price-to-earnings ratio of 10.7, for an earnings yield of 9.4%. To me, this looks very undervalued, both in historic and geographic terms.
Meanwhile, the Footsie offers a forward dividend yield of 4.2%, one of the highest yields of all major stock markets. Even better, this payout is covered 2.2 times by earnings, which is a decent margin of safety.
Over the past year, the FTSE 100 has returned exactly 10%, including dividends. Given that I aim to take an income of 4% a year from invested capital, this is more than enough for me.
Therefore, although dividend investing is a more risky strategy for generating passive income, it works for me. Indeed, I can hardly wait to buy more cheap FTSE 100 shares next month!
