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Investing in UK stocks may be one of the best ways to build passive income. At least I think so. why? That’s because FTSE 100 has some of the highest yielding dividend stocks in the world.
Despite the turmoil of the pandemic, the index is still expected to return 4.1% in 2022, well above the S&P 500’s 1.37%.
Dividends can be boring compared to the excitement of explosive share price opportunities. But in the long run they can be a huge source of recurring income. Take Warren Buffett’s investment in Coca-Cola as an example. In 2021, he earned $672 million from dividends alone. After decades of increasing dividends, that equates to a recurring 52% annual return on his first $1.3 billion investment 34 years ago.
With that in mind, let’s take a look at how you can harness the power of dividends and compound yields to eventually say goodbye to your day-to-day work.
Become a millionaire with UK stocks
On average, when dividends are factored in, the FTSE 100 generated an annual return of around 8%. So, if you invest 10,000 lump sums into a low-cost tracker fund today, you can expect to have around 10,800 a year, about 400 of which come from dividends.
Since the stock market is a volatile place, such performance is clearly not guaranteed. And you may end up earning less or losing money. But let’s assume that the historical average will continue to repeat in the near future. Based on this assumption, compounding 8% over 34 years, my portfolio would be worth just over 136,900.
Not bad. But definitely not enough to retire. And it certainly isn’t enough to generate 5-digit passive income. But if you keep investing little by little every month, it starts to get interesting. With a relatively small monthly capital investment of 500, the UK stock portfolio of the same period ventured into the millionaire realm of 1,124,000!
45,000 passive income generation
Assuming a dividend yield of 4.1% is maintained, the 1.12 million portfolio I envisioned would yield 46,084 passive income per year. If you build a national pension on top of that, it seems like a pretty comfortable retirement.
Obviously, if inflation is working, such a portfolio will lose value in the future in terms of consumer spending power. And, as we’ve seen recently, stock markets tend to crash from time to time as companies withstand economic headwinds.
Conflicts inevitably happen again at some point. Many UK stocks will undoubtedly reduce, suspend or even cancel their dividend payments in such a scenario. However, you can mitigate the impact of such events by diversifying your portfolio. And by having the right amount of cash, you can withstand this temporary stock market downturn.
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