When people think about boosting their income, the first idea is often to take on a second job. The trouble is, that means giving up more time and energy (two of the most important finite resources we possess).
In contrast, building a portfolio of dividend shares takes very little energy beyond the mental effort of learning the basics. Once it’s up and running, the cash dividends flow into an investing account.
Here, I’ll show how it’s possible to construct a stock portfolio from scratch that generates £48k a year in passive income.
Getting the ball rolling
The first thing most newbie investors in the UK do is open a Stocks and Shares ISA. This account shields any returns — including dividend income — from being taxed.
The annual contribution limit is £20,000, which is more than most people have spare after taxes and living costs. This is borne out in the statistics, which show that most ISA account holders don’t max out their annual limit.
For our purposes then, I’m going to assume someone is able to invest £700 every month — the equivalent of £8,400 a year — and less than half the limit.
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.
Strategy
Next, there needs to be an investing strategy. This will be different for each person, depending on age, risk-tolerance, and more.
However, I tend to think there are three strategy buckets, broadly speaking. There are dividend stocks, growth shares, and passive investing centred around index funds and exchange-traded funds (ETFs).
Of course, I’m simplifying things here, and there’s nothing stopping someone from mixing it up. Indeed, that would naturally produce a diverse portfolio, which is important because individual dividends aren’t guaranteed.
Insurance giant
One income stock that I think is worth considering is Aviva (LSE: AV.). After its recent acquisition of rival Direct Line, the company commands over 20% of the UK’s home and motor insurance markets, with more than 21m customers.
In H1, operating profit jumped 22% to over £1bn, and that was without the acquisition. The balance sheet looks in tip-top shape and the interim dividend was hiked 10%.
Naturally, the acquisition isn’t assured to be a slam-dunk success. There could be problems integrating the two firms, while the cost efficiencies Aviva plans to unlock may never materialise.
However, the FTSE 100 stock’s trading at 12 times forward earnings, while offering a near-6% dividend yield. At the current price, I still see value in Aviva, even though it’s currently trading at a 17-year high.
Pouring fuel on the compounding bonfire
When it comes to building passive income, delayed gratification is better than instant gratification, in my opinion.
In other words, rather than taking the income now, an investor could reinvest dividends back into the portfolio to aim for a much larger sum in future. Doing so would supercharge the compounding process, where interest is earned upon interest, like a snowball rolling down hill.
So, let’s imagine someone achieved a 9.5% average return on their £8,400 per year. This sum isn’t guaranteed, but it is the ballpark figure for an ISA account in the UK over recent years, so is therefore more than realistic.
In this scenario, the portfolio would grow to £800,000 after 25 years (excluding platform fees). At this point, the ISA would be throwing off £48,000 per year in dividends, assuming a 6% yield.
