As one of the world’s most successful investors, Warren Buffett’s notion of passive investing remains the Holy Grail of making money. It is simply: “If you don’t find a way to make money while you sleep, you will work until you die.”
For me, there is no more effective way of making passive income than investing in high-dividend-paying shares. The shares I choose are also part of the most highly-regulated stock exchange in the world – the FTSE 100.
This means that there is reliable data on the sort of price and yield returns I can expect. These will both fluctuate constantly, but the data can help me assess long-term performance trends.
From its creation in 1984 to the end of 2022, the index’s price return was 645.2% — 5.3% a year. Its total return including average yield over that period was 1,514.92% — 7.48% a year.
There are many stocks in the FTSE 100 that yield considerably more than this. Companies I have bought primarily for their payouts include Phoenix Group Holdings, Legal & General, and Aviva. These currently yield 11.2%, 9.2%, and 7.8%, respectively.
There is always a risk here, of course, of another major financial crisis at some point. This could lead to a period of reduced dividend payouts from FTSE 100 stocks.
Even in a regular trading environment, stock prices change constantly, and there is the risk that they lose value. Additionally, yields alter over the short term along with share prices, and long term with changing annual dividend payments.
On the other hand, there could be significant share price appreciation over whatever period the shares are held. This would boost returns even more dramatically.
Applying the ‘50/30/20’ rule
An often-used method for managing personal finances is the ‘50/30/20’ rule. This splits the distribution of personal income into expenditure across three categories.
‘Needs’ – including groceries and housing costs – should account for 50% of income spent.
‘Wants’ – including restaurant meals and holidays – should take up 30%.
And ‘Savings’ – including dealing with retirement expenses, having a cash account, and other investments – should see 20% earmarked for it.
With paying down debt also included in each of these Savings categories, investments should account for 5% of total income earned.
The current average salary in the UK is £33,402 gross, or £26,736 after tax and other deductions. Therefore, the budget per month for investments here would be £111.40, or £3.67 a day.
The magic of compounding
£3.67 is less than a pint of beer or a sit-down coffee in many places across the UK. But it is stunning the effect on someone’s wealth that foregoing these can have over time.
This is due to the magic of compounding in investment. This means earning returns on the original investment and the previous returns made.
£3.67 a day invested every month in FTSE 100 stocks that mirror its average 7.48% a year returns yields a £20,000+ investment fund within 10 years. But it should be noted that inflation would reduce the buying power of the pound over time.
That said, after 23 years of the same, the fund will have grown to £83,000. At that point, it will be paying over £6,000 a year (£500 a month) in passive income.
