UK investors seeking passive income have a competitive advantage as FTSE 100 stocks pay some of the most generous dividends in the world. The index is forecast to yield more than 4.4% next year, while a heap of companies pay a lot more than that.
If my Stocks and Shares ISA was empty, I’d want to start generating income as soon as possible. Every year lost is a missed opportunity, as my figures show.
Let’s say I divided this year’s £20,000 allowance equally between five of my favourite high-yielding FTSE 100 stocks. I rate these stocks so highly that I’ve bought four of them in recent months. The fifth is now top of my shopping list.
I’m after a steady stream of dividends
When picking these five stocks, I used two broad criteria. First, I wanted a juicy yield. Second, I was after a low valuation. I also checked for risks, to make sure I wasn’t walking into a value trap and their yields look sustainable (although that’s never guaranteed).
Wealth manager M&G looks like an oversold stock with bounce-back potential plus a whopping yield of 9.66% that might just prove affordable. Insurer and asset manager Legal & General Group comes close with a thumping 8.47% yield.
I also hold mining giant Rio Tinto, which yields 7.75%, and Lloyds Banking Group, which is forecast to yield 6.1%. I don’t hold housebuilder Taylor Wimpey, which yields a mighty 7.94%, but I plan to put that right before it goes ex-dividend on 12 October.
Combined, these five dividend heroes offer an average yield of 7.98%. If I put £4,000 into each, I would pocket dividends of £1,596 over the next year. All of which I would reinvest to build up my position in these five shares.
See how income builds over time
Now let’s make two assumptions. The first is that my retirement is 30 years away and I remain invested in these five shares throughout. Then let’s assume none of their share prices grow, so all I get is the yield.
In that case, after 30 years I would have £200,138. That’s 10 times my original sum. Its real value will be eroded by inflation but it’s still a lot. If I then drew my 7.98% yield as income, I’d get £15,971 a year.
Now let’s say I did generate some share price growth, say, a modest 3% a year. My portfolio would be worth £455,378 after 30 years and yield a thumping £36,339 a year. Not bad for an initial £20k stake.
Plenty can happen over three decades, of course. One or two of my stock picks could struggle or even go bust. They might cut their dividends or dump them all together. Or they could outperform. It could go either way.
Also, I wouldn’t just invest one year’s ISA allowance, but would invest year after year, in a wider portfolio of shares, not just five. That way I could end up with a lot more income than £36k a year.
Whatever happens in practice, I believe my theory holds good. By holding high-yielding income stocks for a long, long time, I can hope to generate a passive income in retirement that far exceeds my original investment. That’s the power of UK dividend stocks.
