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If an investor wants to create passive income, then investing in dividend-paying stocks might be worth considering.
This is because your only focus will be on researching different companies and picking the best stocks that you think are capable of yielding consistent streams of income. In terms of managing the company, there’s nothing investors need to do.
A Stocks and Shares ISA is a very tax-efficient way to try and achieve this. It’s a type of individual savings account where we can invest in shares without paying any dividend tax on income received. If we decide to sell our shares, there’s also no capital gains tax on gains realised. We can invest up to £20,000 a year into this account.
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.
Getting there quickly… or slowly
If an investor were to simply invest in a FTSE 100 index fund, they would yield 3.27%. This would mean they could avoid the stress of stock-picking. However, even with a diversified index like the Footsie, there’s still volatility risk, especially if economic conditions are likewise.
This would require an investment of £1,834,862 to achieve that £5,000 monthly sum. That’s one mighty number (and well above the £20k annual limit so it would take more years than most investors have available). Not an easy amount to find!
With careful and diligent stock picking and a focus on income stocks, I reckon an investor could target a higher yield of 5%. That would still cost £1.2m though.
But not all is lost. A young investor could still aim to achieve this by retirement. With an initial sum of £25k in a portfolio yielding 5% in dividends, and then subsequent reinvestment of dividends plus contributions of £400 a month, they could have a portfolio worth £1,256,393 in 35 years. This is assuming an annual dividend growth rate of 2% and share price appreciation of 5%.
While I appreciate having £25k to invest, and setting aside £400 may not be easy for many, it still presents a much more realistic way to achieve this passive income.
Furthermore, investors should understand that share price increases and dividends aren’t necessarily guaranteed.
A share to consider
I think investors should consider BP (LSE:BP) shares for their portfolio if they’re aiming to achieve this passive income.
With a dividend yield of 5.69%, it’s above the target of 5%. This will help to bring the average yield of their portfolio up.
Moreover, the oil giant’s shares may be worth considering aside from its dividend, too.
The company’s recent Q2 results saw net profit of $2.35bn, comfortably beating the $1.81bn of analysts’ expectations. This is impressive considering it came in a period of lower oil prices.
There’s potentially an extra reason to be optimistic about its prospects. Its latest exploration discovery in the Bumerangue block in Brazil’s Santos basin looks very encouraging. BP is carrying out tests on the site, and no reserve estimate has been provided yet, but this could be a major catalyst for the company over the next few years.
One concern I have with the oil giant is that its net debt of $26bn is quite substantial. This makes its financial position riskier than one might like.
However, on balance, there’s still plenty to like about BP’s shares, and they’re still worth investors considering.
