Owning shares can be a straightforward way of earning passive income in the form of dividend.
Things do not always go smoothly — dividends are never guaranteed, after all. But if I buy into a cross-section of high-quality businesses today, I hope I could benefit by earning passive income for years to come.
If I had £50,000, here is how I would invest it to try and generate £4,000 annually in dividends.
Target yield
That would require me to earn an average 8% dividend yield.
Often I would say that could be challenging while sticking to high-quality companies.
But right now, quite a few blue-chip FTSE 100 firms offer a yield of 8% of above, including British American Tobacco, Imperial Brands, Legal & General, M&G, Rio Tinto and Vodafone.
Not only that, but my target yield is 8% on average. So not every share I buy would need to offer that yield, as long as my £50,000 portfolio did overall.
On top of that, there are various investment trusts I could consider that also offer yields of 8% or more right now.
It is almost an embarrassment of riches!
Spreading the investment
I would diversify my portfolio, spreading the £50,000 evenly over five to 10 shares.
That would hopefully cushion the blow if one of my choices decided to cut its dividend. Both Imperial Brands and Vodafone have done so at some stage over the past few years.
Even now, Vodafone’s high yield (it is over 10%) suggests that at least some in the City think another cut could be on the cards in future.
I would also be sure to spread my money over different business sectors. Quite a few high-yield shares right now are in the financial services sector, for example. I would happily buy some of them, but would not want my portfolio to be overexposed to any one sector.
Hunting for future payers
With passive income as my objective, the question I would focus on is what sort of shares look set to pay out in future.
So I look for companies with a competitive advantage in an industry I expect to benefit from strong demand. That can give them pricing power, which often forms the basis of strong operating profits.
But other things matter too. For example, even if a company makes a large operating profit, a lot of debt can mean that it uses those funds to pay interest rather than dividends. Indeed, the debt pile at Vodafone is something that has been putting me off buying the shares.
Buy to hold
If the balance of risk and possible reward looks right to me, I would be happy to make a move and add the shares to my portfolio.
As a long-term investor, I buy to hold. So if the investment case remained unchanged, I would be happy to hold many high-yielding FTSE 100 shares for years on end.
