Building a second income from scratch can feel like an overwhelming task. But what if all it took was the cost of a morning coffee to eventually start earning £1,000 every single month?
That’s the potential offered by top-quality, high-yield dividend stocks. And right now, Legal & General (LSE:LGEN) could be in that category, with many investors having it at the top of their shopping lists. Why? Because it currently boasts one of the highest yields in the entire FTSE 100 index at 8.64%, rewarding shareholders with cold, hard cash.
So if I’m aiming to take advantage, how long would it take to earn a £1,000 monthly passive income? And is it even a good idea?
Running the numbers
At an 8.64% yield, a portfolio would need to be worth around £138,889 in order to generate a £12,000 annual income, or £1,000 a month.
That’s obviously a big number. But with dividend reinvestment, hitting this threshold is far easier than most people might think.
Let’s assume the current yield stays roughly where it is and every dividend payment gets ploughed straight back into buying more shares. With a disciplined £5-a-day drip feeding approach, the journey to £139k could be completed in just under 24 years.
That’s certainly a journey that will require a lot of patience. But it could end up being much shorter if the share price rises along the way, generating additional capital gains. And the timeline could be accelerated even further if Legal & General continues its impressive dividend hike spree.
Fun fact: shareholder dividends have been increased every year since 2010 (excluding the pandemic)!
So will the yield hold up?
Legal & General’s a cash-generating machine, powered by a recent surge in demand for annuities in the wider pension risk transfer (PRT) market.
More crucially, unlike most of its peers, the firm’s PRT exposure extends beyond the UK and into the US – a market that’s estimated to be roughly five times larger. And the combination of impressive growth opportunity, reliable dividend track record, and chunky yield is a big reason why Legal & General shares are so popular right now.
But it’s important to also highlight the risks. This is a complicated business with a lot of moving parts. Selling annuities today is proving quite lucrative. But it also creates a lot of new long-term liabilities that management will have to cover using its diversified portfolio of bond and private credit investments.
This alone isn’t a major problem. The problem emerges if a painful recession comes knocking. If the group’s investments suffer due to rising default rates or even credit impairments, Legal & General may struggle to keep up with its annuity payments, squeezing both the balance sheet and shareholder dividends.
In fact, investors have already seen this first-hand in the aftermath of 2008, where dividends were slashed by over 30%.
What’s the verdict?
For investors seeking to build a second income and who are comfortable with taking on the macroeconomic risk, Legal & General shares certainly look quite promising today. And while the stock isn’t quite the right fit for my own portfolio, patient investors looking to drip feed a fiver a day for a long-term prize may still want to take a closer look.
