UK shares are a popular choice for passive income. And with good reason. As I write, no fewer than 40 FTSE 100 shares offer forecast dividend yields of 4% or more.
Here, I’ll discuss how much an investor might need to generate a £2,000 monthly income and how long it might take to reach that target. I’ll then highlight an example investment to consider for a reliable income.
How much cash is needed?
A monthly income of £2,000 is equivalent to an annual income of £24,000. The standard advice often used by financial advisers is that 4% is a safe withdrawal rate, with the amount withdrawn increased in line with inflation each year.
Based on that 4% rule, my sums suggest an ISA fund of £600k would be needed to support an initial £24k annual income.
How long would it take?
The maximum contribution allowed to a Stocks and Shares ISA each year is £20,000. The long-term average annual return from the UK stock market is about 7%. So someone investing £20k a year and earnings the average UK market return would take just under 17 years to build a £600k ISA pot.
The investor’s contributions would total £340k, with the remainder generated by investment gains and the miracle of compound returns.
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.
Where to invest?
How to invest the cash? One option is to try and outperform the market by investing in a portfolio of shares. The downside of this is that there’s no guarantee of success and it can require a lot of time.
One simpler option I’d consider would be to invest in a low-cost index fund. Returns will only ever be in line with the market average, but there’s no risk of underperforming.
When the time comes to start withdrawing an income, one option I’d consider would be to invest in a selection of investment trusts, focusing on so-called Dividend Heroes. These are trusts that have increased their dividends yearly for at least 20 years.
One of my favourites that I think is worth investors considering is City of London Investment Trust (LSE: CTY). Founded in 1891, it boasts 58 years of unbroken dividend growth and currently offers a 4.9% dividend yield. That’s significantly more than the 3.5% currently offered by the FTSE 100.
City’s objective is to provide long-term income and capital growth. Just over 80% of the portfolio’s UK shares, with the remainder invested in other developed markets, including the US.
For an idea of the kind of stocks the trust invests in, here are City’s top 10 holdings at the time of writing:
- HSBC Holdings
- Shell
- RELX
- Unilever
- British American Tobacco
- BAE Systems
- Imperial Brands
- Tesco
- NatWest Group
- AstraZeneca
One other attraction is that City of London pays shareholders an equal dividend every quarter, smoothing out the dividend income it collects from all of its shares.
Next step…
There are lots of possible ways to generate an income from shares. But the power of compounding means that the most important decision is to start as soon as possible, to let compound gains do the heavy lifting.
