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How do you fancy earning £1,000 in passive income next year? And double that amount the following year, growing by £1,000 a year, perhaps for decades?
That may sound like a pipe dream. In fact, it can be a realistic goal for those who are determined. Here is how.
Using the stock market as your cash machine
Each week, FTSE 100 companies pay more than £1bn on average in dividends to shareholders. Those shareholders can be big pension funds and asset managers, but also private investors with modest sums put into the stock market.
By building a portfolio of dividend shares, an investor can aim to share some of those payouts as passive income.
As for my figure of £1,000 a year, that is based on someone investing £20k each year (the standard annual contribution allowance for a Stocks and Shares ISA) at a 5% yield.
It is that simple – no compounding the dividends or waiting a long time to withdraw the passive income from the ISA.
Obviously, £20k a year is a lot to invest. Serious ambitions take serious commitment. The same plan could work with less cash, although the income would be correspondingly smaller.
Are dividends a reliable source of passive income?
That 5% is well above the 3.1% average yield of the FTSE 100 currently but I see it as a realistic target even while sticking to proven, large companies.
However, it is worth remembering that no dividend is ever guaranteed to last. So a 5% yield today could turn into a smaller one in future, with negative impact on the passive income streams.
Then again, if the dividends grow (as can happen), the yield could get higher over time, meaning more passive income.
Critically I think, the smart investor needs to decide carefully what dividend shares to buy. Looking at today’s yield is no guarantee of what may happen in future. So it is important when investing to understand what a company’s business is, how its cash flows look and what the trajectory of its financial performance looks like.
This well-known income share’s worth a look
One dividend share I think merits consideration is FTSE 100 insurance giant Aviva (LSE: AV). The company is the nation’s leading general insurer by some distance, giving it economies of scale in a large market that benefits from resilient customer demand. Its acquisition of rival Direct Line has helped to beef up its already commanding position.
One risk I see is the UK focus, given that the Direct Line acquisition has further concentrated Aviva’s business in its home market, as has a shrinking international footprint over the past few years.
If the UK insurance market experiences strong price competition – for example because a smaller competitor wants to try and take some of Aviva’s market share – that could hurt the firm’s profits.
Still, while there are some negatives, I see a lot of positives. The firm cut its dividend in 2020 but has been growing it handily since. Aviva now yields 5.4%.
Aviva’s strong market position gives it a good foundation for growth and the large customer base presents plenty of opportunities for selling multiple financial products to existing customers.
What income stock do we like better than Aviva Plc right now?
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Christopher Ruane does not hold any positions in the companies mentioned.
This story originally appeared on Motley Fool
