The FTSE 100’s home to some of the biggest and most proven businesses in Britain. And with the majority offering a stable recurring dividend, many investors rely on the UK’s flagship index to generate a second income.
But let’s say someone wants to leverage the stock market to quit their job and live off dividends? Just how big does their portfolio need to be to achieve this level of financial freedom? Let’s explore.
Crunching the numbers
The required portfolio size ultimately depends on the lifestyle someone wants to live. It goes without saying that being happy with a passive income of £30,000 a year isn’t going to need as large a nest egg compared to someone seeking £50,000.
But let’s be ambitious and target £50k. Looking at the FTSE 100 today, the index offers a dividend yield of 3.3%. And at this level of payout, an investment portfolio would need to grow to just over £1.5m. That might seem like an unachievable goal, but that’s not necessarily the case, even for investors with modest sums of capital.
Looking at the FTSE 100’s long-term track record, the index typically delivers an average total return of around 8% a year. So if an investor puts just £500 to work each month and reinvests dividends along the way, they could eventually reach the £1.5m threshold in just under 38 years.
| Monthly Contribution | £500 | £750 | £1,000 | £1,500 |
| Time to reach £1.5m | 38 Years | 35 Years | 30 Years | 26 Years |
Speeding up the process
It takes time to build a £1.5m portfolio. But if investors decide not to rely on index funds and pick FTSE 100 stocks directly, they may not need £1.5m.
Take a look at BP (LSE:BP.) as an example to consider. The shares currently offer a far more impressive dividend yield of 6.1%. And at this level of payout, earning £50,000 a year only needs an investment portfolio valued at £820,000. That’s almost half, and assuming BP still generates an 8% total return, the journey to financial freedom is similarly cut.
| Monthly Contribution | £500 | £750 | £1,000 | £1,500 |
| Time to reach £820k | 31 Years | 26.5 Years | 23.5 Years | 19.5 Years |
So problem solved? Well, not quite.
BP’s indeed a mature and established player in the energy sector. And with management pivoting back towards more revenue reliable fossil fuels earlier this year, free cash flow generation is set to grow at a greater than 20% compounded rate between now and 2027. That means more money for reinvestment, debt reduction and, most importantly, dividends.
However, even as a FTSE 100 enterprise, there are still plenty of risks investors must consider. Beyond the general volatility of commodity prices, BP’s strategic reset introduces a lot of execution risk.
Part of the plan involves disposing of certain assets which have caused production volumes to suffer in the short term. At the same time, even with debt reduction efforts, so far, leverage is still moving in the wrong direction. And both of these headwinds are putting pressure on dividends.
Being less than a year into the revamped strategy, I think it’s too early to tell if it’s working as expected. As such, BP’s risk profile’s a bit too high for my tastes. But for investors with a higher risk tolerance, the stock could merit a closer inspection, given the potential rewards.
