UK shares are a terrific way of generating an income without having to actually go to work and earn the money. That’s because FTSE 100 stocks pay some of the most generous dividends in the world, and investors can rely on them for income when they retire.
Many investors underestimate the power of dividends. They fixate on share price growth, but in the longer run, dividends could make up the bulk of your returns from UK shares.
2020 was a bad year for dividends. Just over half the companies on the FTSE 100 scrapped or suspended their payouts, but plenty still came through. Better still, many companies now plan to restore lost payouts. Dividend payments on the index are forecast to rise 18% in 2021, to £10.9bn.
I’d buy UK shares and relax
This year, the FTSE 100 is forecast to yield 3.8%. That’s less than before the pandemic, but remains a generous level of income, especially when compared to cash.
Now let’s say I invested £10,000 in a low-cost FTSE 100 index tracker. That would generate dividends totalling £380 a year, and I wouldn’t have to do anything to get them.
As I’m still working, I would reinvest all the dividends I receive back into my portfolio. That money will roll up, year after year, with share price growth on top. Even if I never invested again, my £10,000 would grow to more than £76,000 after 30 years, assuming the long-term average growth rate for the FTSE 100 of 7% a year.
After 40 years I would have almost £150,000, from an initial stake of just £10,000!
If I raised my game and invested £5,000 every year in UK shares, I would have an incredible £1.14m after 40 years, again, assuming a total return of 7% a year. This would put me into millionaire territory.
Invest, sit back, relax
You may have heard of something called the 4% rule. This is beloved of financial planners, and suggests that if an investor withdraws 4% of their portfolio each year as income, their capital will never run out.
This means that somebody who has a £1.14m portfolio could safely generate a passive income of £45,716 a year. That may be worth less in real terms by the time they retire, due to inflation, but should still be pretty healthy, especially with the State Pension on top.
If I leave my money invested in UK shares throughout my retirement, it will continue to grow, and generate a rising income. That’s because companies endeavour to increase their dividends over time, giving investors more and more for their money.
To make a success of investing, start as early as possible, and stick with it. Picking the right UK shares will help. It is possible to make big money by sticking to household names in the FTSE 100, given time. Perhaps with a sprinkling of smaller, whizzier growth stocks as well.
It really is possible to retire early on a passive income, thanks to the compounding power of UK shares.
You could start with these top stocks.
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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.