Passive income is the dream of many. And why not? I’d challenge anyone not to enjoy making money whilst you eat, sleep, and generally enjoy life! It’s also the financial key to unlocking a great retirement. And as someone who’s already retired in their forties, I really need that passive income to be reliable and long-lasting.
Now I could keep it simple and very safe by investing in the latest best-paying savings account. At the time of writing this, that would be Chase’s new 1.5% offering. That’s better than what’s been available for a while. But it’s not going to keep pace with current inflation levels by any stretch.
And that’s the big problem for passive-income investors such as myself. How do I inflation-proof my income without chasing higher-yielding investment products? Can I simply buy up all those tempting individual shares with +10% yields?!
Sadly, it’s one of those inconvenient truths that any increase in return carries extra risk. And that risk is harder to handle when you are already retired. Dividend cuts and share-price crashes are tougher to wait out when you are relying on the income. So, what to do? Well, for me, the answer has always been diversification.
My simple way to diversify passive income from UK dividends
Enter the iShares UK Dividend UCITS ETF (LSE: IUKD). This exchange-traded fund looks to replicate the, perhaps lesser-known, FTSE UK Dividend+ Index. It does this by holding the top 50 individual high-yielding dividend stocks from the FTSE 350, excluding investment trusts.
The index works out which companies to include by applying a few screening criteria. Some are simple, like a stocks’ trading liquidity. But the main one (unsurprisingly) ranks company dividend performance – both for the previous year, as well as those forecast for next.
This happens twice a year and those companies that make the cut are then weighted with respect to this dividend performance factor and their market capitalisation, subject to an overall 5% cap. It’s not perfect by any stretch but it’s not something I get any choice about.
You will no doubt recognise many of the familiar names that end up featuring prominently in this ETF. In top spot is Rio Tinto, closely followed by the two big tobacco companies, British American Tobacco and Imperial Brands, for example. Overall, there are a lot of value-based and consumer essential types – which should hold up well long-term.
But what matters is the resultant dividend yield for my passive income purpose. And sitting at ~5.5% currently, this quarterly dividend stacks up well. Especially for something with protection against single dividend cuts through its diversification.
Now as ever, there’s no such thing as a free lunch and, like all other ETFs, there’s a charge associated with this investment, albeit a relatively low one of 0.4% annually. When I consider the work involved, and the individual trading costs I’d incur, to create the same thing, it seems reasonable to me.
My main concern with this ETF is its UK focus. I really prefer to diversify globally, so I’ll need to keep my investment in proportion from my overall portfolio perspective.
Overall, for me, the benefit of having this diversified passive income easily outweighs the small cost – and I shall sleep easier for it!