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How much could buying a range of blue-chip UK stocks produce by way of passive income?
That depends on how much one invests, for how long — and in what shares. Let’s use an example to work through those factors in turn.
How much to invest
Some people drip feed money on a regular basis into a share-dealing account or Stocks and Shares ISA.
As I see it, such an approach can have some advantages. Even small contributions can add up over time and I also like the discipline of regular investment across the economic cycle.
But it is also possible to invest with a lump sum. In this example, I will use a figure of £10k, which is only half of most adults’ annual ISA contribution allowance.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Taking the long-term view
Over time, dividends can be reinvested and hopefully earn more dividends. This is known as compounding – and it can be powerful.
Say someone invests £10k at a 5.8% yield. That could start earning £580 annually in passive income from day one.
Alternatively, compounding at 5.8% for 10 years, the portfolio ought to be worth over £17k. At a 5.8% yield, it could then generate around £1,019 per year in dividends.
Building a portfolio
That 5.8% is the average yield of a handful of UK stocks – all in the FTSE 100 or FTSE 250 — I think investors should consider.
Phoenix Group already yields 7.2% and aims to grow its dividend per share annually. It benefits from a large customer base, though any property market crash could hurt valuations in its mortgage book.
Asset manager M&G has its work cut out to get policyholders to put more in than they take out. That is a risk to earnings. But with a strong brand and resilient asset management demand, the 6.3% yielder could do well in future.
ITV yields 6.2%. A weak advertising market could hurt it, though this summer’s World Cup may help. It makes money from renting out production studios, as well as broadcasting itself.
City of London Investment Trust yields 3.8% and has grown its dividend per share annually since 1966.
Its focus on blue-chip UK stocks gives it a risk profile I like, although it does mean any UK economic downturn could hurt its net asset value.
Long-term opportunity, or value trap?
The fifth UK stock also has decades of dividend growth under its belt: British American Tobacco (LSE: BATS).
I recognize that some investors shun tobacco shares on ethical grounds. For those that do not, British American offers a global manufacturing footprint and distribution network.
Its portfolio of premium brands gives it pricing power it can turn into profits and dividends. The current yield is 5.5%.
Will the dividend last?
The big risk I see here is the relentless decline in cigarette use. The share could end up being a value trap if British American sees cigarette sales revenues collapse and cannot replace them.
But it has been growing its non-cigarette product portfolio. Its brands give it pricing power that can help mitigate cigarette volume declines by raising selling prices.
