The UK’s premier league of listed companies — the FTSE 100 — has long been a great source of passive income for regular investors like me.
Today, I’m going to look at how I can bring in £1,000 a year for arguably the least amount of risk I can take.
The best bit is that this method only requires a few minutes of my time.
Stock-picking
Before going any further, let me be clear that I fully understand the appeal of wanting to search for, and buy, stakes in single company stocks. After all, some in the index have dividend yields as high as 10%!
I’d struggle to find that kind of return anywhere outside of the stock market.
But there’s a problem. Some of the highest payers are also those most at risk of not being able to pay up when the time comes.
Why’s this? Well, a sky-high yield suggests that a company is going through a sticky patch. Perhaps sales have dropped, or investors are concerned about rising debt levels.
If it looks like a business is struggling financially, there’s a danger the dividend stream could be reduced, or cut completely. This concern can lead to some shareholders jumping ship, pushing the price down and raising the dividend yield even higher.
If it looks too good to be true, it usually is.
Beauty in simplicity
Fortunately, I can neatly minimise such worries if I want to. A fuss-free alternative to building an income portfolio from scratch is to simply buy the index in its entirety as part of a diversified portfolio.
In practice, this means investing some cash into an exchange-traded fund (ETF) that tracks the return of the FTSE 100.
As well as growing in value as the index (hopefully) rises over time, I’ll also receive dividends for sitting on my hands.
Right now, the top tier yields 3.8%. That’s not as much as that being offered by some of its members. Then again, I can take comfort from knowing that my money is spread around a huge variety of stocks. If one or two are forced to cut, others should make up for it.
This method is also efficient. The strategy described here can be achieved with one mouse click. This is assuming I’ve already set up a tax-efficient Stocks and Shares ISA.
I’ll pay a fee for holding the fund. But the beauty of ‘passive’ vehicles like this is that costs are low. Keeping my holding in an ISA also means I won’t pay any tax on the dividends I receive!
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.
Long-term mentality
For balance, it’s worth being realistic about how patient I’ll need to be to reap the rewards of this approach. To generate around £1,000 a year at today’s yield, I’ll need to have a little less than £27,000 invested.
That’s a lot of money for most people. But I don’t think this should stop me from getting started. It’s surprising how saving a little every month (and possibly increasing these amounts after a while) can add up over time.
Getting into the habit of reinvesting whatever passive income I receive will only serve to bring that goal closer. And with my passive income coming in, I can devote more time to researching individual stocks to hopefully generate even higher returns.
