Last year, banking giant HSBC doled out £8.4bn in dividends. Some of that went to institutional shareholders. Some went to strategic investors. And a fair bit went to people who own HSBC – and other UK shares — primarily because of their passive income potential.
In fact, a lot of investors focus their passive income efforts on buying shares in proven blue-chip companies that typically pay out dividends to shareholders.
That can be lucrative, though, like any investment, it comes with some risks.
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Below I outline how an investor could target a £2,000 per month average income either now or down the line by buying UK dividend shares.
Doing the dividend maths
To begin, I will explain the maths.
A monthly £2k equates to £24k per year. How much someone needs to spend on shares to earn that will depend on the average dividend yield of the shares they buy. Dividend yield is basically the dividends earned annually as a percentage of the cost.
So, for example, at a 5% yield, it would be necessary to spend £480k on shares to hit the passive income target.
That is a lot of money. But one good thing about the current valuation of many blue-chip UK shares is that it means the yield can be quite attractive.
While the FTSE 100 average yield is 3.6%, in today’s market I think it is realistically possible to target 7% while sticking to quality companies.
Why a long-term approach can help
Still, even at 7%, the upfront investment needed would be substantial, at around £343,000.
But for those serious about setting up passive income streams and willing to take a long-term approach, there is another way, even starting from zero.
For example, say that an investor puts £860 per month into the stock market and it compounds at 7% (by reinvesting dividends initially).
After 18 years, the portfolio will be big enough so that, at a 7% yield, it can generate over £2k each month on average as passive income.
Finding shares to buy
I said I think a 7% yield is realistic in the current market.
One of the UK shares I had in mind in that context, that I think investors should consider, is British American Tobacco (LSE: BATS).
There is clearly a big risk here: the company makes most of its money selling cigarettes and demand for those is declining in most markets.
Still, although in decline, it remains huge – British American sells billions every week. Thanks to its portfolio of premium brands, it has pricing power that enables it to fund a big dividend.
The yield currently stands at 7.9%. British American also has a track record of raising its dividend per share annually for decades, although that does not necessarily mean it will keep doing so.
Although cigarettes are a declining market, non-cigarette sales are growing fast. I think British American’s well-established brands can help it do well in that space.
Getting ready to invest
One thing I have not mentioned above is the practical side of getting started.
That would take a way to buy UK shares, such as a dealing account or Stocks and Shares ISA.
With lots of choices available, it can pay for an investor to take time and research what looks best for them.
