Building up sizeable enough savings to earn a passive income isn’t a walk in the park, but it’s definitely within reach. With the right mix of dedication, patience, and savvy stock picks, it can become a reality.
For investors with some spare cash to save, there are plenty of ways to put it to work. One low-effort (but long-term) approach is investing in dividend-paying companies.
It’s not a surefire strategy, but many renowned investors have used it successfully over the years. To boost the chances of success, certain key steps can make all the difference.
Reduce costs and maximise gains
Investment profits are often subject to tax, so cutting these costs is a smart first move. For UK investors, a Stocks and Shares ISA offers a tax-efficient solution.
With an annual allowance of £20,000, this account allows investments across various assets with a tax break on the gains. There are many options to open one — whether through a high street bank or a range of financial providers.
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.
Consider diversifying
To safeguard a portfolio against single points of failure, many investors adopt a diversified approach. This involves selecting a mix of assets from various industries and regions to reduce the impact of any single loss.
For example, growth stocks offer higher potential returns, while dividends provide a steady income stream. Meanwhile, defensive stocks tend to hold their value when other assets are crashing.
Each brings its own benefits to the table.
Passive income stocks
My passive income portfolio includes a few defensive shares like Tesco, GSK, and Unilever. I also hold a few well-established dividend stocks like Legal & General, Aviva, and National Grid.
When it comes to maximum returns, however, my top dividend stock has long been British American Tobacco (LSE: BATS). With a 7.8% yield, the tobacco giant has a long history of consistent dividend growth.
Unfortunately, tobacco is a problematic industry with an uncertain future. The devastating health effects of smoking attract increasingly strict regulations.
That’s part of the reason the share price is down 43% since its high in 2017.
Still, I think the company’s pivot to less harmful products will be successful. Already, the shift is proving beneficial, with the shares up 32% in the past year.
There’s a risk it could fail to transition profitably — or be regulated out of business. But for now, I like its odds and believe less harmful products will ultimately benefit tobacco addicts.
Calculating returns
If an investor saved £5 a day for 10 years, that would amount to £18,250. But if they put that into a portfolio with an average 7% yield and 3% price growth, it could grow to £33,524 (with dividends reinvested).
The dividends on that would amount to £1,700 a year, or £4.65 per day – almost the same as the contributions.
Another 10 years and it would have grown to £97,426, paying dividends of £3,721 – over £10 per day!
This example shows how an investment could go from costing £5 a day to paying £10 a day. Plus, the investor would have almost £100,000 in savings.
