It’s amazing how relatively small amounts of money can build into a meaningful pot over time. Today, I’m looking at how a small but regular saving could create a useful passive income. I often buy a caffè latte from a well-known coffee shop and it costs me around £3. If I were to buy one every day, that totals around £1,000 every year. But I reckon by investing this money instead I could eventually fund my coffees for life.
Where to find passive income?
One of the best ways I know to create passive income is by investing in a basket of dividend shares. Some companies pay a share of their profits to shareholders in the form of dividends. It’s important to choose selectively though. Some firms decide to reinvest profits back into the business instead of paying income to shareholders.
One of the ways to differentiate between them is to look at their dividend yields. The average FTSE 100 dividend yield is currently 3.3%. For a £1,000 investment, that would give me £33 in passive income in the form of dividends. Many UK shares offer much more than the average yield. And some sectors are known for offering relatively high and stable dividends. For instance, utilities, telecoms, and financials include several stocks that pay over 5% in dividends. That’s £50 of passive income a year on my £1,000 investment.
That might not sound like a great amount but if I continue to save up and add to my pot, my total investment should grow. That should lead to a greater dividend income over time. For instance, if I saved up £10,000, I could potentially achieve a chunkier passive income of £500 every year.
Which dividend shares?
To begin, I’d split my original £1,000 investment and find three companies I’d like to invest in. To reduce my risks, I’d also pick shares from different industries. Right now, from the financial sector I’d consider Legal & General Group. This insurance company offers a 6.5% dividend yield and has a near three-decade history of paying regular dividends. Although past returns can’t guarantee future returns, it’s interesting to note that over the past decade its shares created a 13% total annual return including dividends and share price gains.
In the telecoms sector, I’d consider Vodafone. It’s another popular dividend share among income investors and I can see why. It offers an above-average 5.5% dividend yield. And like Legal & General, it has a long history of consistently paying dividends. Some companies put particular focus on distributing excess cash to shareholders and I’d say Vodafone is one of them. Its share price has drifted lower over the past decade, but with a return to post-pandemic normality, I reckon it could be due a recovery.
The utilities sector tends not to be particularly exciting, in my opinion. Usually, share prices barely move. That said, it offers reasonable opportunities for passive income. For instance, energy company SSE offers a 5% dividend yield that it has paid for 29 years. Another advantage of buying a utility share is that its relative stability is often sought-after in times of crisis.
By investing in these three stocks, I’d currently achieve a dividend yield of 5.7%. I’d like their share prices to rise over time too, but even if they don’t, I’d be happy with this chunky passive income.