Earning a passive income sounds like a dream. Imagine earning a gentle trickle of cash each week that takes zero time and effort on your part once it’s set in motion.
In retirement, the second income dream becomes necessity, and it’s more achievable than many people realise. Investing in FTSE 100 dividend income stocks is a terrific way to generate it. You can buy them either inside a Self-Invested Personal Pension (SIPP) or Stocks and Shares ISA. Or ideally, both.
Let’s say we target a passive income of £250 a week, which works out as a handy £13,000 a year. How much do you need to generate that?
Joy of stocks and shares
This depends on a number of factors, including how much your portfolio yields. Let’s say an investor builds a portfolio of dividend stocks that delivers a relatively high average yield of 6% a year. To achieve that, they’d need £216,667 in their tax-free ISA wrapper.
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.
Investing small monthly sums can multiply and grow over decades. Let’s take the example of 30-year-old who already has £10,000 in their ISA. If they invested a modest £100 a month on top of that, and generated an average total return (with invested dividends) of 7% a year, they’d have £284,262 by age 65.
That’s comfortably above my target and in this case a 6% yield would deliver income of around £17,056 a year, which works out as £328 a week.
British American Tobacco’s a dividend giant
I’d hope to generate a higher total return, by investing in individual FTSE 100 stocks rather than simply tracking the index. One worth highlighting is cigarette maker British American Tobacco (LSE: BATS).
A few years ago, cigarette makers looked burnt out, with sales hit by health concerns, regulatory clampdowns, falling smoking rates in the West and ethical qualms (I share them myself).
Yet British American Tobacco has performed surprisingly well. It still pumps out cash by selling more than 500bn ‘sticks’ a year, while expanding its range into vaping and smokeless nicotine products.
Over the last 12 months, the share price is up a stunning 53%. The trailing dividend yield’s about 5.6%, well above the FTSE 100 average of around 3.5%.
FTSE 100 overachiever
The price-to-earnings ratio is around 11.6, comfortably below the FTSE 100 average at about 15. So it looks decent value although of course there are risks. Health campaigns and regulatory clampdowns will surely continue. Also, the shares have had a strong run, and growth may slow from here. But I still think they’re worth considering today, with a long-term view.
I’d look to build a balanced spread of at least a dozen stocks. That way if any underperform, hopefully others will more than compensate.
I’d suggest investors increase their monthly contributions over time, as their income rises. Then keep re-investing those dividends until they need to draw them as passive income at retirement. It’s the best route I know to financial freedom.
