Generating a passive income from buying UK shares is my favourite way of building wealth over time. But that does not mean I just slavishly look for stocks with the highest yields. This is particularly the case when looking in the lower-tier FTSE 250 index, which tends to exhibit more volatility than the FTSE 100.
Trading update
One company that has caught my attention recently is asset management giant Aberdeen (LSE: ABDN). The woes affecting the business have been well documented. However, I am becoming increasingly optimistic about its prospects after years in the doldrums.
Improving underlying fundamentals have seen the stock rise 70% since hitting an all-time low back in April.
Its Q3 update highlighted that outflows from its key Adviser business have continued to come down. Net outflows for the quarter halved to £500m. Total year-to-date outflows now stand at £1.4bn.
I put this improvement down to two factors. First, a comprehensive repricing across its fund portfolio. Second, significant investment in client experience, particularly improving service levels.
These are exactly the kind of initiatives that could entice more independent financial advisers (IFAs) to sign up to its platform. Today, it already serves around half of all IFAs in the UK, representing over 400,000 end customers.
Compounding gains
The stock may have bounced back strongly, but it still offers an inflation-busting dividend yield of 7.1%.
As the business continues to rebuild, its dividend per share is unlikely to rise before 2027. However, I can offset that by reinvesting my yearly dividends to buy more shares.
The following chart highlights the power of compounding in action. Each year, as I reinvest those dividends, I am effectively creating a self-fuelling income machine. Every new share I buy adds its own dividends to the mix – and those dividends, in turn, buy even more shares.
After around seven years, the results become dramatic. The curve steepens, and my portfolio growth really takes off. It is easy to see why Albert Einstein reportedly called compounding the “eighth wonder of the world”.
Risks
The asset management industry is evolving rapidly, driven by the rising popularity of low-cost tracker funds.
It is estimated that more than half of all global capital is now invested in instruments such as exchange-traded funds (ETFs). Their low fees and instant diversification have rewritten the rules of investing, while at the same time eroding the profit margins of traditional asset managers. This shift has been a key factor behind the long-term decline in active management strategies.
Aberdeen was slow to respond to this threat and has been playing catch-up ever since. While recent progress shows promise, the company remains exposed to continued fee compression and intense competition from passive products.
Bottom line
The runaway success of Aberdeen’s direct-to-consumer platform, interactive investor, highlights the untapped potential within the business.
I am not expecting an instant turnaround in its fortunes, but the chance to lock in a very attractive 7.1% dividend yield while waiting for longer-term share price recovery is a major plus in my view.
That is why I’ve recently added the shares to my portfolio – for the combination of high income today and the potential for future growth.
