Finding the right passive income strategy is a great way to prepare for a financially secure future.
High-yield savings accounts are one option. They’re useful for short-term goals, but long-term investors will likely see their wealth eaten away by inflation. A buy-to-let property might be a good alternative. However, high UK house prices put that beyond reach for those with just £10,000 to invest.
That’s why I think buying dividend stocks is a superb passive income option to consider. Using this method, patient investors could eventually aim to generate £1,500 per month from a five-figure starting sum. Here’s how.
Investing wisely
Not all businesses pay a dividend. For example, popular US stocks, like Amazon and Tesla, have never rewarded shareholders with passive income.
The investing landscape is rather different for UK shares. Among FTSE 100 stocks, 99% issue dividends! There’s plenty of homegrown choice for those seeking regular cash payouts.
When looking for dividend shares to buy, yield is a crucial consideration. Essentially, this is the company’s dividend per share expressed as a percentage of the current share price. For reference, the average FTSE 100 yield is 3.56% today.
But that can be beaten. Some shares in the index offer yields of 7%, 8%, and even over 9%.
A top dividend stock
One FTSE 100 stock to consider is British American Tobacco (LSE:BATS), which yields a mighty 7.61%.
It’s got a great history too. The firm’s dividend growth streak stretches back nearly three decades — a key reason why it’s in my portfolio.
For my sins, I confess to being a smoker. That’s less fashionable to admit these days since the terrible health consequences are well-known.
An increasingly health-conscious global public is shunning this addictive vice. Fewer consumers, government regulation, and punitive taxation are major worries for the industry’s future, and, by extension, British American Tobacco shareholders.
Those risks are reflected in a low valuation. Trading at a forward price-to-earnings (P/E) ratio of just 8.8, there’s a compelling case that British American Tobacco shares are in bargain territory today.
Despite gloomier predictions about the company’s outlook, it remains a highly profitable enterprise. Huge underlying profits of £11.9bn in FY24 and free cash flow of £7.9bn bode well for continued bumper dividends.
Plus, although cigarettes may not have a long-term future, the business reckons nicotine still does. It aims to become a predominantly ‘smokeless’ firm within 10 years thanks to products such as vapes, heated tobacco, and oral pouches. I think there’s a good chance the doomsayers will be proved wrong about the group’s eventual demise.
Compound returns
Dividends and share price growth aren’t guaranteed. Accordingly, investors would be wise to diversify their holdings across different companies and sectors. However, if all goes to plan, the potential rewards are alluring.
From a diversified mix of dividend stocks like British American Tobacco, a 6% aggregate yield’s achievable. That means investors would need a £300,000 portfolio to generate £1,500 in monthly passive income.
Starting with £10,000 and assuming a 10% compound annual growth rate from capital appreciation and dividend payments, it would take under 36 years to get there. That’s a long time, but younger readers have time on their side to build a passive income empire for retirement.
