Investing in UK shares has long been a worthwhile means of making a passive income. However, at the present time, it could prove to be even more attractive than it has been in the past.
A number of UK stocks offer high dividend yields, as well as impressive dividend growth potential. Therefore, over the long run, they could turn a modest monthly investment into a surprisingly large income return.
Making a passive income today
Clearly, it’ll take many years for a monthly investment of £250 to become a passive income that’s large enough to replace a salary. However, UK investors can start making a relatively high income return from FTSE 100 and FTSE 250 shares today. The indexes themselves may yield less 4% after their recent rallies. However, within them are companies such as Vodafone and Imperial Brands that offer dividend yields in excess of 6% apiece.
Buying a diverse range of companies is likely to help an investor in obtaining a sustainable income return in 2021 and beyond. A broad portfolio of stocks means that an investor is less dependent on a small number of companies for their income. Since political and economic risks are currently high, reducing risk through diversification may be even more important than is normally the case.
Developing a growing income from UK shares
Of course, UK shares also offer the chance to build a growing passive income over the long run. As such, investors may wish to reinvest any income they receive from shares in the short run. This will allow their portfolio to grow at a faster pace as a result of the impact of compounding.
For example, the historic returns of the FTSE 100 are around 8% per annum, including reinvested dividends. A monthly investment of £250 that achieves that market rate of return over a 30-year time period could be worth around £375,000. From this, a 4% annual withdrawal equates to an income of £15,000.
Furthermore, many UK shares are likely to offer higher dividend growth and total returns than the index over the long run. Buying them now while they trade on low valuations in many cases may allow an investor to outperform the wider stock market. This may produce a larger portfolio that provides a greater passive income return, as well as a stronger dividend growth opportunity.
Taking a long-term view
Clearly, 2020 has been a tough year for passive income investors. Many UK shares have cut or cancelled their dividends in response to challenging operating conditions caused by coronavirus.
Therefore, taking a long-term view of an income portfolio could be a sound move. It may allow an investor to look beyond short-term risks to capitalise on high-yielding shares. And that could ultimately offer a very attractive income return over the coming years.
Peter Stephens owns shares of Imperial Brands and Vodafone. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.