Finding high-quality stocks that generate passive income became increasingly important to me after I turned 50.
This is because such shares can provide significant dividend streams with little effort on my part (hence the ‘passive’ label).
I intend to use these to continue to reduce my working commitments as I age. Of course, such income can be drawn on earlier in life, to make it much more comfortable.
One stock I have held for several years for its passive income flows is Rio Tinto (LSE: RIO). This has averaged an annual dividend yield of 7.34% over the five years from 2020 to 2024.
In 2024, it paid a dividend of 402 cents, fixed at a sterling equivalent of 310p. This gives a current dividend yield of 5.8% on the present £53.38 share price.
This is slightly below the 7% minimum I generally demand from my passive income stocks. The figure factors in my ‘compensation’ for taking the extra risk involved in share investment over no risk at all. And currently the ‘risk-free rate’ (the 10-year UK government bond yield is 4.5%).
So, I am wondering now whether I should keep it or buy a higher-yielding stock?
There are several options available
The present average dividend yield of the FTSE 100 is just 3.3% and of the FTSE 250, 3.5%. However, within those indexes there are several very high-yielding stocks, some of which I already own.
These include Legal & General (8.8%), Phoenix Group Holdings (7.9%), and M&G (7.6%). They are all underpinned by exceptionally strong annual earnings growth forecasts to end-2027. Specifically, these are, respectively, 56%, 106%, and 34%.
So, I could sell Rio Tinto and invest the proceeds in these.
However, this would increase my weighting in financial sector holdings, which contradicts the diversification I want. This minimises the effect on my overall portfolio of a downturn in any sector or stock. And all stocks have risks attached.
So how does this commodities giant look?
A risk to Rio Tinto’s earnings is any long-term drop in global commodities prices.
But China – the world’s biggest commodities buyer – looks set to meet its 5% economic growth target this year, I think. Q1 saw it hit the 5.4% level, while it was 5.2% in Q2. Q3’s came in on 20 October at 4.8%, against expectations of 4.7%.
Additionally positive for Rio Tinto, in my view, is the major reorganisation it announced on 27 August. This involves the streamlining of its huge commodities interests into three distinct business units. I believe this should cut costs, increase profits, and boost shareholder rewards.
As of now, my £20,000 holding in the stock would make £15,671 in dividends after another 10 years based on an average 5.8% yield and ‘dividend compounding’.
After 30 years, this would rise to £93,470.
And that would pay me an annual passive income from dividends of £5,421.
On balance, I think I will keep my Rio Tinto holding. It has decent annual earnings growth prospects of over 5%, which I think will improve significantly after its reorganisation. And I believe these may well drive its dividend yield over 7% again soon.
That said, this does not preclude me from looking at further passive income opportunities elsewhere.
