£9,500 in savings? Here’s how I’d try to turn that into £535 a month of passive income

Relatively small investments in high-yielding stocks can grow exponentially through the power of dividend compounding into significant passive income.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Passive income text with pin graph chart on business table

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Making money with minimal daily effort remains the core of the passive income idea. And the best way I have found of doing this is by investing in stocks that pay big dividends.

I use these payouts to buy more of the same stocks – known as ‘dividend compounding’. Consequently, the size of my investments grows, paying me more and more in dividends over time.

One such stock in my high-dividend portfolio is Legal & General (LSE: LGEN).

A new financial crisis remains a risk for the shares, of course. Another is that high inflation and interest rates deter new client business.

An ideal pick for my high-yield portfolio

The company has three key features that I want to see in all my high-yield stocks.

First, it has maintained a high payout all year, based on its 2022 dividend of 19.37p per share.

Because yields fall as share prices rise, the payout has dropped recently to 7.75%. Although still a high FTSE 100 yield, the firm intends to increase the dividend by 5% in 2024.

The second feature is that despite the recent share price rise, the stock is still very undervalued against its peers. This means there is less likelihood of a major share price fall wiping out all my dividend gains.

On the key price-to-earnings (P/E) ratio, it trades at just 7.4, compared to the peer group average of 18.1.

A discounted cash flow analysis shows the stock to be around 56% undervalued at its current price of £2.50. Therefore, a fair value would be nearer £5.68, although this does not necessarily mean it will reach that level.

And the final feature of an ideal stock in my high-yield portfolio is a strong underlying business.

Legal & General’s retirement solutions operation is a market leader in the UK Pension Risk Transfer (PRT) space. This is where a company takes over other firms’ pension scheme commitments and is paid for doing so.

It is also in the top 10 in the US PRT market, which has enormous growth potential. Only around 9% of the US’s $3trn of defined benefit pension schemes have been transferred so far.

Legal & General Investment Management is also a leading global asset manager, with £1.2trn of assets under management.

Its H1 results showed it is on track to achieve its target of £8bn-£9bn by the end of this year. This on its own can prove a powerful engine for growth.

The dividend-compounding miracle

With £9,500 of savings (£26 a day for a year) I could buy 3,800 Legal & General shares today. With a yield of 7.75% a year, I would make £736.35 in the first year of dividends.

Reinvesting the dividends would give me £89,175 after 30 years if the yield averaged the same over the period. This would pay me £535 a month in passive income.

However, if I continued to pay £26 a day into this stock, I would reach this income after just six years.

Through continued dividend compounding, the portfolio would be worth £1,224,399, and paying me £7,558 a month in passive income. This is based on the yield averaging the same over the period.

Inflation would erode the buying power of the income. But the figures underline what big things can come from such small beginnings.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Simon Watkins has positions in Legal & General Group Plc. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

US Stock

Here are the best-performing S&P 500 stocks after the US election result

Jon Smith notes some of the largest gainers from the S&P 500 yesterday and explains how the election result has…

Read more »

Growth Shares

2 UK stocks knocking on the door of promotion to the FTSE 100

Jon Smith points out a couple of UK stocks that he feels could be ready for the big league based…

Read more »

Investing Articles

Rolls-Royce shares just fell 7%. Is it time to buy?

This investor in Rolls-Royce shares takes a look at the FTSE 100 engine maker's trading update to see what caused…

Read more »

Young Black woman looking concerned while in front of her laptop
Investing Articles

What’s going on with the Auto Trader share price?

Paul Summers takes a closer look at why the Auto Trader share price has tumbled despite the company posting higher…

Read more »

Investing Articles

Legal & General shares look set to give me a mind-blowing 10.22% yield in 2026!

Harvey Jones is getting a brilliant second income from his Legal & General shares and expects even more to come.…

Read more »

Investing Articles

I’d consider this beaten-down FTSE 100 dividend stock to target a second income of £19,000

Our writer sees an opportunity to earn a substantial second income by investing in this UK insurance giant. Here’s his…

Read more »

Investing Articles

How cheap is the 72p Vodafone share price?

The Vodafone share price looks very cheap having fallen to a 72p price tag. But is it really the bargain…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

Up 43% in a year and the IAG share price could keep on rising!

One of the FTSE 100’s highest-flying stocks still looks cheap on an earnings basis. Is this a brilliant buy for…

Read more »