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When it comes to earning passive income in the stock market, UK shares stand out among the best investment options. That’s because many British businesses, big and small, offer some of the most generous dividend policies anywhere in the world. And by executing a consistent long-term investing strategy, investors can go on to earn a chunky passive income stream that could potentially replace their primary salary. Here’s how.
Earning almost £4k a month
Right now, the biggest UK shares offer a respectable dividend yield of 3.3% when looking at the FTSE 100. However, digging a little deeper reveals that there are currently 16 stocks in Britain’s flagship index with payouts in excess of 5%. And this number rises to over 70 when zooming out to include the FTSE 250 as well.
That’s more than enough companies to start building a diversified portfolio capable of delivering at least a 5% dividend yield. And assuming it also generates another 4% in capital gains each year, investing £500 a month at a 9% return for three decades can grow an impressive £915,400 nest egg, generating the equivalent of a £3,815 monthly passive income with dividends. For reference, £180,000 would be investor capital with the remaining £735,400 being investment profit. But of course, if the investor doesn’t achieve 9% (after all, it’s not guaranteed), the passive income will be much lower.
Intelligent stock-picking targets
Just because a stock’s offering a high yield doesn’t automatically make it a good investment. In fact, often, the higher the yield, the greater the risk, even if the underlying business is large enough to be in the FTSE 100.
Let’s zoom in on Aviva (LSE:AV.) as a prime example to consider. At a market-cap of around £20bn, the company definitely has the advantage of size on its side. And as one of Britain’s leading insurance groups, its industry-leading status also provides greater investment security.
Moreover, thanks to elevated interest rates, Aviva has enjoyed a pretty favourable economic environment that’s helped boost cash flow and earnings. So much so that shareholder payouts have been hiked every year since 2020. And with management steering the business to become more capital-light, dividend sustainability could be set to improve even as interest rates slowly fall.
So far it’s 5.5% dividend yield’s sounding pretty attractive. But like with all investments, nothing’s guaranteed. And there are some critical risks that could compromise dividends in the future.
Risk versus reward
A big part of the strategic move to becoming a less capital-intensive business is Aviva’s recent acquisition of Direct Line. This deal has helped diversify its revenue streams and insurance product portfolio. But the integration process is far from complete and remains quite complex.
Delays or a lack of expected synergies could stall growth and margin expansion. That obviously wouldn’t be good news for the bottom line, especially if continued interest rate cuts continue to squeeze profit margins at the same time. And considering the group’s existing dividend coverage is already relatively modest at around 1.3-1.4, its tasty-looking 5.5% yield could be only temporary.
These risks are why I’m not rushing to buy Aviva shares today. But luckily, it’s not the only high-yield passive income opportunity available right now. And by digging deeper into lucrative-looking UK shares, investors can potentially discover phenomenal wealth-building opportunities.
