Passive income from dividends

This £20k ISA delivers £1,961 of cash passive income a year© Provided by The Motley Fool

As a long-term investor, I like buying shares in good businesses at fair prices. Also, my investing style nowadays favours value shares and passive income. Thus, when share prices plunge — as they did during the recent market meltdown — I see these falls as opportunities to buy at a discount.

Hence, I’m often drawn to cheap shares offering market-beating dividend yields to patient shareholders. As my family doesn’t need this income right now, we reinvest our dividends by buying more shares. Over time, this increases our corporate ownership and boosts our total long-term returns.

Passive income from dividends

Though share dividends are my favourite form of passive income, they’re no sure-fire route to riches. Indeed, returns from value/income investing have lagged behind those from growth investing for most of the last 15 years. Also, these three problems can cause problems:

1. Future dividends aren’t guaranteed, so they can be cut or cancelled at short notice. For example, during 2020-21’s Covid-19 crisis, dozens of UK companies slashed their payouts to preserve cash.
2. After paying out dividends, companies have less cash at hand. Therefore, paying out excessive dividends can weaken companies over time.
3. After paying out dividends, companies have less cash at hand. Therefore, paying out excessive dividends can weaken companies over time.
4. Super-high dividend yields, say, 10%+ a year, can warn of future problems. History has taught me that double-digit cash yields rarely last. Either share prices rise, or dividends get cut, dragging down yields.

Three shares would deliver an average dividend yield of 9.8% a year. Therefore, a mini-portfolio of equally weighted holdings in all three stocks would generate passive income of £1,961 annually. Furthermore, this cash stream would be tax-free inside a Stocks and Shares ISA.

In particular, I like the look of M&G as a long-term producer of passive income. M&G was founded in 1931 and launched the UK’s first unit trust that same year. The current share of 186.75p translates into a huge cash yield of 10.8% a year. But this yield has leapt due to recent falls in the M&G share price. This is down 13.4% over one month and 7.2% in a year, but is ahead 43.4% over five years (excluding dividends).

Then again, what if things turn sour again for financial markets, as happened recently? With £312bn of assets under management, M&G’s profits and cash flow could get slammed if stock and bond prices plunge further. Even so, I note that its yearly dividend has risen from 15.77p a share for 2019 to 20.1p for 2024. In short, this passive income looks sound to me!

The post This £20k ISA delivers £1,961 of cash passive income a year appeared first on The Motley Fool UK.

Of course, there are plenty of other passive income opportunities to explore. And these may be even more lucrative:

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Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?