Adopting a passive income investment strategy could be a great way to retire early or, at least from a financial perspective, have a more comfortable old age.
However, to be successful, I believe it requires some up-front research and a lot of self-discipline. Personally, I prefer to focus on the FTSE 100. Generally speaking, the companies on the index have strong balance sheets and a global reach. This means their earnings tend to be more stable and their dividends more reliable. Of course, there are no guarantees.
In my opinion, there’s a need to be disciplined because better long-term returns are achieved by reinvesting the dividends received. This short-term sacrifice should help generate a higher level of passive income later in life.
This is best illustrated using some numbers.
A five-stock portfolio
The table below contains five high-yielding FTSE 100 stocks.
The average return is 7.3%. Investing an equal amount in each would result in a £20,000 Stocks and Shares ISA generating £1,460 in dividends every year. This would help pay for a good package holiday.
But if the dividends earned were reinvested by buying more stocks, it would be possible to generate a higher return. After 25 years, the portfolio would be worth £116,419 and could be producing income of £8,499 a year.
At this point, an investor could adopt an alternative strategy and take the dividends as a second income. The amount earned each year would then be enough for a luxury cruise.
| Stock | Dividend yield (%) |
|---|---|
| M&G | 9.7 |
| Taylor Wimpey | 8.2 |
| British American Tobacco | 7.3 |
| Land Securities Group | 6.8 |
| BT Group | 4.6 |
| Average | 7.3 |
Buyer beware
However, as impressive as this appears, my analysis carries a few health warnings.
Firstly, history may not be repeated. Dividends can fluctuate in line with earnings.
Also, I’m assuming that share prices will remain unchanged. In reality, they could go up or down, which will affect the overall value of the ISA.
Finally, some would argue that a well-balanced portfolio should contain more than five stocks. I regularly read that 20-30 is the ideal number to hold. However, I’ve seen one academic paper that suggests over 200 is the correct answer! Personally, I don’t think there can be a definitive rule as it will largely depend on the overall value of the holdings as well as the investor’s risk appetite.
A closer look
The highest-yielding stock in the table is M&G (LSE:MNG).
In cash terms, the savings and investment group’s 2024 dividend — of 20.1p — is 10.3% higher than its 2020 payout. And analysts are predicting further increases over the next three years – 20.6p (2025), 21.2p (2026), and 21.8p (2027).
Since 1 May 2020, the group’s share price has risen 61%. But this includes a post-pandemic bounce back. Looking back four years, it’s remained virtually unchanged, suggesting investors are unlikely to see significant future capital growth. This makes the dividend even more important for shareholders. But as we have seen, reinvesting these payouts can help compensate for a lacklustre share price.
In common with all businesses, the group faces some challenges. It operates in a highly competitive industry that could reduce its assets under management (AUM) and its margin. It’s also vulnerable to an economic slowdown.
However, its long history, good reputation, strong balance sheet, and growing AUM should help underpin its earnings and enable it to steadily increase its payout. Therefore, it could be a high-yielding dividend stock for income investors to consider.
