One of the most fuss-free ways of generating passive income, in my opinion, is to buy shares in dividend-paying stocks. Holding these within a Stock and Shares ISA also means I don’t pay any tax on the cash I receive. Today, I’m looking at which companies from the FTSE 100 index I’d spend my £20,000 annual allowance on.
Before getting stuck in, it’s worth highlighting a couple of things I avoid doing when screening for great dividend shares. The first of these is not searching for the biggest dividend yields on offer. This might seem counter-intuitive, so let me explain.
Since they’re negatively correlated, a high yield could be the result of a company’s share price crashing. This could be due to a whole host of factors, but it’s usually the result of a slowdown in trading. This reversal in fortunes often leads to a dividend being reduced, or withdrawn completely, in an effort to shore up cash.
In addition to avoiding seriously high yields, I also tend to avoid companies whose earnings are cyclical. Instead, I look for those stocks that should enjoy consistent demand for whatever goods or services they provide. In theory, this should mean they’re far more likely to provide a reliable income stream for their holders. This is partly why I steer clear of investing in banks, for example.
So, which stocks from the FTSE 100 take my fancy right now?
FTSE 100 dividend stocks to buy
Thanks to the predictability of their earnings, I think it’s likely utility stocks would take up a fair chunk of my £20,000 ISA allocation. Within this, I’d include FTSE 100 juggernauts such as National Grid and perhaps a water firm such as Severn Trent.
Elsewhere, consumer goods giant Unilever would make the cut, as would drinks firm Diageo. In addition to boasting portfolios stuffed with brands people are willing to pay for, both have a truly global reach and should recover strongly once the pandemic subsides. With a 27% share of the UK grocery market, I’d also take a position in Tesco.
Of course, it’s vital to be diversified. So, although I’d prefer its dividend payouts to be growing, some of my capital would go to pharmaceutical giant GlaxoSmithKline. To counter this lack of growth, I’d add health & safety firm Halma, due to its great track record of increasing its cash returns.
A word of warning
While I’d feel confident holding any of the above shares as part of a FTSE 100-focused, passive income-generating strategy, this is not to say such a portfolio is devoid of risk. ‘Black swan’ events like a global pandemic have shown us that nothing can be guaranteed.
Away from inevitable crashes and corrections, investors also needs to bear in mind dividend policies can always change. Tesco may be the UK’s biggest supermarket right now but this may not be the case in, say, 2030. GlaxoSmithKline may be snapped up by a deep-pocketed suitor.
If this were to worry me, there’s an alternative. Instead of buying individual company stocks, I could simply buy a cheap exchange-traded fund that tracks all stocks within the FTSE 100. While this would likely generate a lower passive income stream, it does allow time-poor investors a way out of the need to keep in touch with their holdings.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo, GlaxoSmithKline, Halma, Tesco, and Unilever. 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.