Investing for passive income seems to me to be a smart approach for long-term investors. By holding shares that will likely pay out a steady stream of dividends, there’s less need to constantly make the right calls. After all, that’s something most investors, even professionals, struggle to do. The majority of investors can’t consistently time purchases correctly, which is what makes trading so hard.
Instead, if I buy dividend-paying shares I can benefit from compounding and, over time, from a growing passive income. This is one of the ways for me to achieve financial independence.
Passive income share no 1
Aviva (LSE: AV), according to stockbroker AJ Bell, is the eighth highest-yielding stock in the FTSE 100 this year. What I like most about it though is that the yield of 6.9% will be covered 2.28x by earnings and the payout ratio is 44%.
That makes the dividend very sustainable. For context, rival Legal & General is anticipated to have lower cover (1.56x) and a higher payout ratio (64%). While these numbers aren’t necessarily problematic, they show Aviva’s dividend should, all things being equal, have more scope to grow.
The new CEO at Aviva is taking steps to make the business leaner, something that previous CEOs were unable to do. Investors seem happy about the developments. The strategy will also leave Aviva focused on the UK, Ireland and Canada.
Tesco under previous boss Dave Lewis executed well on a similar strategy, as have Aviva’s peers in the insurance sector. It makes me think the Aviva share price and yield could head upwards. That makes it potentially a very good share for passive income.
Another share with a high dividend yield
Imperial Brands (LSE: IMB) won’t make it into many portfolios on ethical and sustainability grounds because of its core product. But if I didn’t mind investing in tobacco, it does have a dependable dividend that makes it good for passive income.
The cigarette producer has a forecast dividend yield of 9.3% for this year. That payout to shareholders is covered 1.85x, which is fairly good, and the payout ratio is 54%. So there are no alarm bells about the sustainability of the dividend there. It has higher cover and a lower payout ratio than its competitor British American Tobacco.
Demand for tobacco is holding up — as Imperial Brands’ latest sales figures show — which, along with cost-cutting, should underpin earnings for a long time to come.
Like Aviva, a combination of a current cheap valuation and high dividend yield make Imperial Brands a potential addition to my passive income portfolio.
Investment trusts with quarterly dividends
But my passive income portfolio wouldn’t only contain individual shares. Many investment trusts pay quarterly dividends and could work well in a balanced portfolio. I particularly like Scottish Investment Trust, which is a value/contrarian investor and holds a lot of gold-mining companies. Another one I hold is Merchants Trust, which is high-yielding and holds many FTSE 100 companies, meaning that if the UK stock market bounces back, it should benefit massively.
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Andy Ross owns shares in Legal & General, Merchants Trust and Scottish Investment Trust. 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.