Passive income describes generating money from doing very little. And what’s not to like about that? But the word ‘passive’ can be misleading. There’s a bit of up-front work needed to identify the best stocks. In addition, it’s important to monitor them on an ongoing basis.
However, generally speaking, it’s possible to generate a healthy level of income with the minimum of effort.
Personally, I like to invest in FTSE 100 companies. In theory, these are the biggest and best that Britain has to offer. Their global reach, experienced management teams, and robust balance sheets means they are less likely to deliver earnings surprises. As a result, most of them regularly return cash to shareholders via steady and reliable dividends.
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Of course, the level of income received is never guaranteed. But according to AJ Bell, the UK’s largest listed companies are expected to pay dividends of £83.6bn, in 2025. This implies a forward yield of 3.9%.
Huge potential
If an investor started with £20,000, a 3.9% return would give them £780 in dividends in year one. Reinvest this and they could receive £810 the following year. Repeat this annually and — after 25 years — they’d have £52,050. After a quarter of a century, this would generate income of £1,954 a year, or £163 a month. But remember, this ignores any capital growth (or losses).
However, there are plenty of shares that offer a better return.
One for consideration
One such example is National Grid (LSE:NG.), the energy infrastructure owner and operator. In respect of its 31 March 2024 financial year (FY24), it paid 54.13p a share. Impressively, since at least 2000, it’s increased its payout every year. And it plans to grow it annually by CPIH (the consumer prices index, excluding housing costs) from FY25-FY29.
The index is currently at 3.5%, which could mean a dividend of 56p next year. With a share price of 963p (17 January), this would imply a yield of 5.8%.
National Grid’s healthy dividend’s possible due to the fact that its principal markets are all regulated. This means it doesn’t face any competition and, as long as it meets certain investment and performance targets, it’ll know what level of return it can generate. And therefore how much cash is available to give to shareholders.
Potential issues
However, energy infrastructure assets are expensive. It plans to spend £60bn over the next five years and its legacy capital expenditure programme has resulted in large borrowings on its balance sheet. At 30 September, the group’s debt was £45.2bn.
Its level of gearing might explain why the company turned its back on debt providers and surprised shareholders in May, by launching a £7bn rights issue.
But despite these concerns, I remain a fan of the company. Its defensive qualities are particularly attractive to me during the current global economic uncertainty. That’s why it’s on my shopping list for when I’m next looking for a FTSE 100 income share.
Returning to my example, applying a 5.8% return to a £20,000 investment would result in £81,879 after 25 years. At this point, the annual dividend would be £4,749, or £396 a month.
Although this is a hypothetical example — it’s never a good idea to invest exclusively in one stock — it does show what’s possible from a portfolio of high-yielding shares.
