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I find it very reassuring to know that beyond my standard income, I have an additional source of funds. For many UK investors, that dream begins with building a passive income portfolio powered by dividend-paying shares.
But earning a meaningful amount of monthly dividends can take decades. Reinvesting dividends can significantly speed up this journey, thanks to the compounding effect. Instead of spending the payouts, an investor who puts them straight back into buying more shares allows the income snowball to grow over time.
How much would it take to reach that £1,000-a-month figure?
With an average dividend yield of 7%, a portfolio worth around £171,300 could generate £12,000 annually. That initial figure may sound daunting, but starting with £200 a month and reinvesting the dividends could build that sum in about 25 years. Starting with a £10,000 lump sum could cut that to roughly 20 years.
Naturally, this depends on what’s in the portfolio. Not all high yields are sustainable, so careful stock selection’s key.
Here are three FTSE 100 shares to consider that collectively average a 7% yield and could form the foundation of a reliable passive income stream.
British American Tobacco
It may be a controversial pick, but British American Tobacco has long been a favourite of dividend investors. Despite a slow shift toward next-generation products, the company remains highly profitable and cash generative.
The current yield’s around 8.7%, underpinned by strong free cash flow and a history of consistent payouts.
Taylor Wimpey
With a yield currently about 6.8%, this British housebuilder has been impressively resilient despite a tough housing market. With interest rates easing, buyer confidence may return, which could help support both earnings and dividends.
Its strong balance sheet and disciplined capital returns policy give it solid passive income credentials.
M&G
The final share is perhaps the most intriguing. M&G (LSE: MNG) offers a forward yield of 7.8% and has grown its dividend at 11% annually over the past five years. That’s rare for such a high yielder.
Plus, the shares have made impressive gains this year, which is even more unusual for a dividend stock – especially one with such a short dividend track record. Meanwhile, broker sentiment’s improved, with Barclays upgrading the stock to Overweight in June, raising its price target to 295p.
However, the fundamentals are mixed. In its latest results, M&G posted a £360m loss, despite revenue growing nearly 29%. The balance sheet looks a bit stretched too, with a debt-to-equity ratio of 2.1, and assets only just exceeding liabilities. With it being a relatively young dividend payer with limited track record, there’s a risk of cuts.
Still, its price-to-sales (P/S) ratio of 0.42 suggests the shares could be undervalued relative to revenue. Analysts expect earnings per share to hit 26p by FY2025, offering an optimistic outlook.
Just the start
This is just one example of how three stocks could kickstart a simple, high-yield passive income portfolio. But it’s important to diversify the portfolio further over time, so it would make sense to add more stocks later.
Spreading capital across sectors and company sizes can help protect income when times get tough, and ensure the journey to £1,000 a month is as smooth as possible.
