Image source: Getty Images
Passive income is money that I don't need to spend a lot of time or effort or have a traditional job to earn. That seems quite attractive to me.
However, without a portfolio of properties to buy and rent, there are not many ways to earn a second income without putting in the hours and effort. However, there is one key way, and it's my favorite: get dividends from stocks.
Buying to let can be rewarding but requires a lot more effort than buying shares. Additionally, rental income and house price growth are taxable, while dividend income and share price growth within a stocks and shares ISA is not.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
Dividend flow
Today, stocks listed on the FTSE 100 They pay an average income of 3.8% per year. But I can generate more by targeting high-yield dividend stocks like these five:
- Legal and General Group — 8.14%
- M&G — 9.89%
- Phoenix group holdings — 10.61%
- Taylor Wimpey — 6.51%
- Burberry Cluster — 5.89%
I also can't afford to invest my entire £20,000 allocation this year, but if I could I would diversify into some other high-income UK stocks.
HSBC Holdings (LSE: HSBA) is high on my shopping list. The Asia-focused bank pays index-crushing income, with a residual yield of 6.99%. It also appears to be good value for money, trading at 7.67 times earnings.
I'm surprised it's so cheap, given that its share price is up 17.93% in the last year and 52.95% in three years. HSBC's profits have also soared, up 78% to $30.3 billion in 2023, as higher interest rates widened margins.
In addition to the dividend, shareholders also benefited from a $7 billion share buyback last year, and the board is moving ahead with a $2 billion buyback in the first quarter.
No action is without risks. When interest rates finally peak, HSBC's margins could shrink. It could also be affected by a trade war between the United States and China. That's why I'll spread my money across different stocks instead of going all-in on just one.
FTSE 100 high returns
If you invested £5,000 in four different FTSE 100 shares with an average split return of 6%, you would make an income of £1,200 in the first year. However, investing is a long-term game. Let's say I left the money in the market for 25 years and it grew at the FTSE 100 long-term average of 8% a year, with all dividends reinvested. My £20,000 would be worth £136,969.
With that 6% return, you would generate an annual passive income of £8,218 a year. Which isn't bad at all considering a one-off investment of £20,000, made 25 years earlier.
Although I wouldn't invest just for one year. He would introduce money into the market whenever he had some to spare. If you invested £20,000 in the first year and £10,000 each year after, you would have £926,514 after 25 years. A 6% return would generate an income of £55,590 a year. Now we are talking.
Obviously there are no guarantees. My shares could underperform. One or two companies could go bankrupt. Alternatively, it could outperform the FTSE 100 average. Either way, the director holds on. Passive income is hugely attractive, and dividend stocks are a great way to achieve this. Without breaking a sweat (although patience is essential).