I’ve created passive income from a variety of methods. But my favourite way is by owning dividend shares in a Stocks and Shares ISA. I find it to be a simple, low-maintenance, and tax-efficient process.
There are hundreds of dividend-paying stocks in the UK. The largest of these reside in the FTSE 100 index.
These mature and established companies are more likely to pay a part of their profits to shareholders in the form of dividends. Faster-growing and often smaller businesses might choose to reinvest profits instead.
But not all Footsie shares are high dividend payers. So, I’d need to do some homework to fish out those that are.
How I’d earn £9k a year
Now, a one-off investment of £20,000 isn’t a realistic sum to create £9,286 of passive income. After all, even a basket of high-dividend shares might yield around 8%.
That’s enough to earn £1,600 in yearly dividends.
But by diligently investing £20,000 every year for just five years, I calculate that my pot should be worth around £117,000. And that should be more than enough to earn over £9k of annual dividend income.
This assumes I invest in shares that offer an average dividend yield of 8%. So let’s see how I could do that.
Finding the best dividend shares
First, it’s important to note that very high dividend yields might not be sustainable. Dividends aren’t guaranteed and can be cut or suspended by management according to the company’s outlook.
That said, I’d try to lower the chances of that happening by focusing on shares that offer stable profits and cash flow. After all, this is where dividends are paid from.
Next, I’d look for a long dividend history. The past can’t guarantee the future. But if a company has been distributing cash to shareholders for over a decade, it gives me some confidence that it could continue.
Then, I’d like to see at least some dividend growth. This is a powerful attribute that can considerably boost my total return over time.
Finally, I’d look for a selection of around five or six dividend shares. Diversifying across several stocks should reduce what’s known as company-specific risk.
If I only picked one stock to invest in and it was hit with some financial instability, my whole portfolio would suffer.
But by spreading my eggs across several baskets, I’d be splitting my risk.
Five passive income stocks
Right now, if I had cash to devote to this strategy, I’d buy Phoenix Group, Hargreaves Lansdown, Natwest Group, Imperial Brands, and Legal & General.
This selection currently offers an 8% dividend yield. It also offers a dividend cover of 1.8, which suggests that they should comfortably be able to afford these payments.
And with an 18-year dividend history, I’m confident in the managements’ long-standing dividend policies. As much can change with individual stocks, I’d need to monitor my selection. But overall, I’d expect to earn plenty of chunky dividends over time.
