When I was 30, I didn’t even know investors could use shares to generate a second income. I knew they generated capital growth when share prices climbed, but didn’t realise they got dividend income, too.
Now I actively target dividend-paying FTSE 100 shares that will give me a high and rising passive income. Now is a good time to buy them, as a dozen blue-chips yield more than 6% a year. A handful yield 9% or 10%. Many are dirt-cheap, too, trading at less than 10 times (a figure of 15 is seen as fair value) earnings.
With my retirement around 15 years away I’m buying all I can afford. But what if I was 30 again and investing £500 in my first ever FTSE 100 stock?
Step by step
Step one would be to open a Stocks and Shares ISA. Then, I’d scour the market for a high-yielding FTSE 100 stock with a cheap valuation. I’d probably start with a solid portfolio holding Lloyds Banking Group, which is forecast to yield income of 5.9% in 2023 and 6.49% in 2024.
Lloyds looks really cheap trading at just 6.5 times earnings. Its share price has struggled lately but may pick up if interest rates fall and markets recover next year.
Once I’d tested the water, I might up my stake in Lloyds or direct my next £500 into another top FTSE 100 income stock, like National Grid.
I’d aim to build a portfolio of at least a dozen FTSE 100 stocks. And I might take a bit more risk by chasing higher yields as my knowledge and confidence grew.
Let’s say I invested £500 a month from age 33, and increased my contribution by 5% a year to maintain its value. How much I get will depend on how well my shares perform. The FTSE 100 has delivered a long-term average return of around 7%. If I matched that, I’d have an impressive £1.52m by age 67. If my portfolio grew at 10% a year, which is what I’m aiming at, I’d have a quite stunning £2.68m.
Inflation will have reduced its real value but that still looks like a tidy sum to me.
Doing the sums
If my portfolio yielded 7% at retirement and I took all my dividends, my £2.68m would give me a second income of £187,520 a year. Even a £1.52m portfolio would give me income of just over £106,000 a year. By investing in Stocks and Shares ISA, that income will free of tax for life.
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.
I accept that investing £500 a month (and rising) from age 33 will be a tall order for many. Also, there is a danger that my portfolio grows at a slower pace than by 7% or 10% a year. Dividends aren’t guaranteed and I may generate less income than I hoped. There are always risks to investing in equities, but for me, they’re outweighed by the outsize potential rewards. Whatever my own final return, I reckon shares beat every rival asset class for both capital growth and second income.
