Passive income is money for which I don’t need to expend much time or effort, or have a traditional job to earn it. That sounds pretty attractive to me.
Yet without a portfolio of buy-to-let properties, there aren’t that many ways of earning a second income without putting in the hours and the effort. There’s one key way though, and it’s my favourite: earning dividends from stocks.
Buy-to-let can be rewarding but it demands a lot more effort than buying shares. Plus rental income and house price growth is taxed, while dividend income and share price growth inside a Stocks and Shares ISA aren’t.
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Dividend stream
Today, stocks listed on the FTSE 100 pay average income of 3.8% a year. But I can generate more by targeting high-yield dividend shares like these five:
- Legal & General Group — 8.14%
- M&G — 9.89%
- Phoenix Group Holdings — 10.61%
- Taylor Wimpey — 6.51%
- Burberry Group — 5.89%
I can’t afford to invest my full £20k allowance this year either but if I could, I’d diversify into a few other top UK income stocks.
HSBC Holdings (LSE: HSBA) is high on my shopping list. The Asia-focused bank pays an index-smashing income, with a trailing yield of 6.99%. It also looks good value, trading at 7.67 times earnings.
I’m surprised it’s so cheap, given that its share price is up 17.93% over the last year and 52.95% over three years. HSBC’s profits have been soaring too, up 78% to $30.3bn in 2023 as higher interest rates widened margins.
As well as the dividend, shareholders also benefited from a $7bn share buyback last year, and the board is pressing on with $2bn buyback in Q1.
No stock is without risk. When interest rates finally full, HSBC’s margins could narrow. It could also get squeezed in a US-China trade war. That’s why I’ll spread my money between different stocks rather than going all in on one.
FTSE 100 high yields
If I invested £5k across four different FTSE 100 shares with an average divided yield of 6%, I’d get income of £1,200 in year one. Investing is a long-term game, though. Let’s say I left the money in the market for 25 years, and it grew at the long-term FTSE 100 average of 8% a year, with all dividends reinvested. My £20k would be worth £136,969.
With that 6% yield, I’d generate an annual passive income of £8,218 a year. Which isn’t bad from a one-off £20k investment, made 25 years earlier.
Although I wouldn’t invest just for one year. I’d feed money into the market whenever I had some to spare. If I invested £20k in year one and £10k every year afterwards, I’d have £926,514 after 25 years. A 6% yield would deliver income of £55,590 a year. Now we’re talking.
Obviously, there are no guarantees. My shares could underperform. One or two companies could go bust. Alternatively, I could beat the FTSE 100 average. Either way, the principal holds. A passive income is a hugely attractive thing, and dividend stocks are a great way of achieving it. Without breaking a sweat (although patience is essential).
