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How share dividends build a huge passive income

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In stock markets, investors’ returns come in two forms. The first is capital gains: profits made by selling shares at higher prices than buying prices. But as share values move up and down, capital gains are by no means guaranteed. Indeed, the FTSE 100 index is lower today than in January 2018, so the index has actually declined over the past 3½ years. The second return comes from dividends: regular cash returns paid by companies to shareholders. Again, dividends are not guaranteed and can be cancelled, suspended, or cut whenever. Due to the Covid-19 pandemic, 2020 saw the UK’s biggest dividend cuts in a decade.

The joy of dividends

As a value investor for over 35 years, I have come to love my dividends. For me, they are the closest thing to free money that I’ve ever had. Of course, I’m not the first investor to appreciate them. American business tycoon John D. Rockefeller once remarked, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

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Investment guru Benjamin Graham, the father of value investing and mentor to US billionaire Warren Buffett, was also a big fan. In his 1949 book The Intelligent Investor, Graham said, “The true investor…will do better if he forgets about the stock market and pays attention to his dividend returns and to the operation results of his companies.” Therefore, Graham counsels investors to ignore share prices and concentrate on underlying company performance and cash payments.

How to grab this cash

In order to earn dividends, one must first be a shareholder. So that means buying shares and holding them until the next pay-out has been accrued. Two dates are important in this process. The first is the ex-div date, the day on which one is no longer entitled to the coming dividend. Thus, buy on this date and you don’t get the next pay-out. Buy the day before and you do. The second is the payment date, which comes generally between two weeks and two months after the ex-div date.

Currently, there are almost 2,000 companies listed on the main market of the London Stock Exchange (the LSE). This number has declined for years (it was close to 2,500 in 2015). However, most of these LSE-listed businesses do not pay out cash to shareholders. Some are loss-making and cannot fund shareholder pay-outs. Others reinvest their profits to generate future growth.

Building a passive income

One way to start building a regular passive income is to buy the shares of dividend-paying businesses. But the distribution of UK company dividends is highly concentrated. According to investment group A J Bell, just 10 FTSE 100 stocks accounted for over half (54%) of 2020’s dividends. Likewise, A J Bell estimates that the top 20 payers account for three-quarters (75%) of 2020’s dividends.

Finally, if you don’t have the time, patience or experience to pick your own company dividends, then the iShares UK Dividend UCITS ETF (LSE: IUKD) can do it for you. This exchange-traded fund owns shares in 50 of the biggest dividend payers from the FTSE 350 index. Its top 10 holdings are all huge, well-known firms. I owned this stock until the global financial crisis of 2007-09. Today, I’ve added it to my buy watchlist as another contender to boost my family’s dividends!

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Cliffdarcy 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.

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