Here’s how dividend stocks with 7% yields could create a £64k+ passive income

I’m planning to fund my retirement with a broad portfolio of dividend shares with high yields and strong payout histories. That way, I can realistically expect to receive a regular and growing passive income while continuing to increase the size of my pension pot.

To reach that point, investors like myself need to have a large enough portfolio to throw off a healthy second income. Fortunately, the long-term growth potential of the stock market means individuals don’t need to invest colossal sums to reach this goal. But it does need a patient and balanced approach.

Here’s how £500 a month in UK and overseas stocks could eventually build a passive income above £64,000.

Diversifying for strength

Whether someone is seeking growth or dividends, building a diversified basket of shares is critical for targeting long-term returns. It allows an investor’s portfolio to better absorb individual shocks. What’s more, this approach can produce a consistent return over time by balancing higher-risk cyclical shares with defensive stalwarts.

This strategy doesn’t need investors need to settle for sub-par returns either. Harry Markowitz — widely considered to be the creator of modern portfolio theory — once described diversification as “the only free lunch in investing.”

Today’s investors can choose from thousands of stocks, investment trusts and exchange-traded funds (ETFs) from around the world. This gives each one of us the power to build a bespoke portfolio suited to our own investment goals and attitude to risk.

Seven picks

Let’s look at what a diversified portfolio might look like:

There might be only seven holdings in this portfolio. But in total, they provide exposure to a whopping 773 different companies, spanning different sectors, regions, and providing a mixture of value, growth and dividend shares.

JD Sports and Polar Capital’s share price have dropped more recently. But they’ve still delivered returns over the long term, and are tipped by analysts as robust recovery plays.

During the last 10 years, this portfolio would have delivered an average annual return of 11.9%. Past performance is no guarantee of the future. But it this continues, investing £500 here each month would grow to £922,923 over 25 years.

If this was then invested in 7% dividend stocks, our investor would enjoy an average annual passive income of £64,605.

A top ETF?

For me, funds like the iShares Edge MSCI World Value Factor ETF are great ‘cheat codes’ for building a well-diversified and high-performing portfolio easily and affordably. It’s why I own several in my own portfolio.

This one holds shares in roughly 400 global companies. It provides “direct investment in global equities which are undervalued relative to their fundamentals,” like book value and predicted earnings.

This approach gives the fund strong growth potential by targeting quality companies priced below their intrinsic value. Key holdings include Qualcomm and Intel, for instance, trading at a substantial discount to industry leader Nvidia and which could theoretically deliver greater long-term share price growth.

Its high weighting of tech stocks could make the ETF more vulnerable during downturns. But I still believe it’s a great fund to consider as part of a diversified portfolio.