Passive income is a great goal. The idea has a lot of appeal, but it’s hard to achieve. With property you either have to pay an agent, or deal with tenants. The latter is anything but passive as I know from personal experience. Getting an income from investing in shares is passive to an extent and can be very rewarding.
In this article I’ll share an example portfolio of UK listed shares, which I think will produce a sustainable passive income which can compound – essentially grow and snowball to become bigger and bigger – over time.
With inflation fears increasing – and consequently many higher rated growth shares struggling – now could arguably as good a time as any to concentrate on income producing shares. Regardless though of the macroeconomic backdrop, I think there’s a place for creating a growing stream of dividends.. I’m certainly keen on the effect compounding can have on my own portfolio.
A portfolio of 8 shares for passive income
The first four shares in my fantasy passive income portfolio of shares were chosen by using investing.com to filter shares by their dividend properties. Putting in criteria of a payout ratio between 25% and 60% along with a dividend growth rate between 7.5% and 90% gave me 74 shares to choose from.
I tried to avoid those I knew had very inconsistent dividends, which ruled out spreadbetters. I also ruled out very low yielding shares given the objective is to create a passive income, so a decent dividend is an important criterion.
On that basis, Polymetal, Mission Marketing, Mattioli Woods and Strix were selected for the passive income portfolio.
To add more dividends throughout the year I’ve also gone for four investment trusts, paying quarterly dividends. They have yields above 3%. These are JPMorgan Global Growth & Income, Henderson International Income, Lowland and Chelverton UK Dividend Trust.
There’s no right or wrong when it comes to how many shares you should hold. Of course, only eight shares would be a very concentrated portfolio. It would in most cases be far better to also hold other investments. I typically have 20-30 shares and funds within my investment portfolios.
Performance of my original passive income portfolio
When I last put together a portfolio of shares that might be good for generating passive income, I included the following:
- Scottish Investment Trust
- National Grid
- PZ Cussons
- Polar Capital
- City of London Investment Trust
- BAE Systems
- Severn Trent
- Belvoir Group
- Schroder Oriental Income
|Investment||% gain since 1st Sept|
|Scottish Investment Trust||10|
|City of London||23|
|Schroder Oriental Income||19|
These are results since the beginning of September 2020 until the time this article was written in May 2021. That period obviously includes quite a strong run for the stock market so, for context, over the same timeframe, the FTSE 100 went up by 20%. The return from the passive income portfolio, excluding dividends was 22%, only slightly ahead of the FTSE 100.
As this is a passive income portfolio the dividends are very important. This is how the dividends that have been paid since September by these shares.
|Scottish Investment Trust||5.7||6.1||5.8||17.6|
|City of London Inv Trust||4.75||4.75||4.8||14.3|
|Schroder Oriental Income||4.6||1.9||1.9||8.4|
The clear winners in the period were the smaller UK shares. With rises over 50%, the AIM listed companies Polar Capital and Belvoir Lettings, led the way when it came to share price growth. The former also has a decent dividend yield.
Overall, I’d maintain this portfolio did well given it has a number of large cap defensive companies and is designed with passive income as the main consideration. That said, I’d be tempted to take out BAE Systems and Severn Trent to boost the overall return from the portfolio.
Key considerations for passive income
So, what are the things it’s worth thinking about when it comes to creating passive income from shares?
When it comes to creating passive income from shares it’s best to consider more than just the dividend yield. As the previous passive income portfolio shows it’s no bad thing to have smaller companies with strong dividend and share price growth prospects. As always, valuation also matters. You need to buy shares at the right price, all the more so if you are only going to hold for a short period of time.
Some of the key questions that need to be answered when it comes to investing with passive income in mind are:
- What is the dividend yield? And is it too high versus similar companies and at risk of being cut?
- What is the dividend cover? Ie. How well covered is the dividend by earnings. If the dividend isn’t covered by earnings or dividend cover is going down year on year then that’s a concern. Usually it would be good to see a dividend cover of above two.
- Has the company been able to grow the dividend and how consistent is the dividend growth?
- Does the company or industry face major structural challenges that could impact on the share price?
- What growth opportunities are there for the company?
There’s a lot of other considerations but I think this serves as a starting point for when it comes to thinking about investing for passive income.
As always this is not investment advice. It is intended to be informative and showcase how it’s possible to use shares to create passive income. Remember shares can go up as well as down.
Please note, that at the time of writing, I own shares in National Grid and Polar Capital. You can see my latest portfolio updates and holdings here.