Creating a passive income from shares

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
  • Admiral
  • 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 Trust10
Admiral11
National Grid14
PZ Cussons24
Polar Capital54
City of London23
BAE Systems4
Severn Trent8
Belvoir53
Schroder Oriental Income19

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.

InvestmentDividendDividendDividendTotal (p)
Scottish Investment Trust5.76.15.817.6
Admiral91.291.2
National Grid1717
PZ Cussons3.132.675.8
Polar Capital99
City of London Inv Trust4.754.754.814.3
BAE Systems9.49.4
Severn Trent40.6340.63
Belvoir Group5.45.4
Schroder Oriental Income4.61.91.98.4

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.  

4 thoughts on “Creating a passive income from shares

Add yours

  1. We have a couple of holdings in common (LGEN and NG). You have bought NCYF as I have sold. If interest rates remain low, will maturing credit be hard to replace? I am surprised you have no AV.. A lumbering giant admittedly, but a decent yield. Are the chances of capital growth too limited?

    Also, would you consider preference shares? Again very limited chance of capital growth, but yields (guaranteed!!) of 6% are still available. Seems like the most resilient place for anyone seeking passive yield. I hold RSAB and AV.B as a core and sleep well at night as a result.
    I am no expert, and most definitely remain inexperienced.

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    1. Hi Bill, thanks for commenting. On AV yes I see it as too similar to LGEN and I’m keen to see how the turnaround pans out. Lots of other PIs seem to be fans and it’s good value. Overall I’m keen to invest not just for income, as I’m working so don’t need to take out the dividends to live on; instead, I’ll reinvest the dividends. I want to see capital growth as well. Andy

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