How I’d target £100 a month in passive income

Key points

• I’d target dividend growth to protect my income from inflation
• Build a diversified portfolio to reduce the chance of big losses
• Aim to beat the FTSE 100 dividend yield

As an investor, my main aim is to generate a reliable passive income that keeps pace with inflation. The way I do this is by investing in good quality dividend stocks.

Targeting shares that pay a rising dividend has two big attractions for me. First of all, it gives me an income that I’ll receive without having to do anything. The second attraction is that if I’ve chosen the right shares, I’ll own a stake in growing businesses. Over time, this should mean the value of my shares also rises.

In short, I see dividend shares as a good solution for passive income and long-term capital gains. Of course, dividends are never guaranteed, and future growth is always uncertain. Even companies that have performed well in the past can run into problems.

Some of my biggest investment losses have been from companies that have looked cheap but performed badly. Sometimes these have resulted in painful dividend cuts. This is why I aim to have a diversified portfolio of 20 stocks. That way, problems at one company should only have a limited impact on the value of my whole portfolio.

£100 per month

How much will I need to invest to generate a passive income of £100 per month? That will depend on the dividend yield from my stocks. My experience is that a share’s dividend yield often provides a big clue about how the market thinks the company will perform in the future.

For example, a very high yield is often a sign that the market doesn’t expect the business to deliver much growth. Tobacco giant Imperial Brands currently has a yield of 8%. To generate £100 a month from Imperial stock, I’d need to invest about £15,000.

This stock should provide an attractive initial income, but I don’t expect this business to deliver much growth over the next few years. This could mean the real value of the payout falls over time, if inflation stays high.

On the other hand, a dividend yield that’s too low may rise quickly, but still won’t provide much income. For example, to generate £100 a month from a stock with a 2% yield, such as drinks giant Diageo, I’d have to invest £60,000.

Passive income: aiming to beat the market

My approach is to aim for a forecast dividend yield from my portfolio that’s just above the FTSE 100 average of around 4%. Right now, I’m aiming for an average dividend yield on my stocks of between 4.5% and 5%.

That means I’d need a portfolio of between £24,000 and £27,000 to generate a passive income of £100 a month.

Of course, this income won’t be paid monthly. Most UK companies pay dividends twice a year. Some, like Unilever and Shell, pay quarterly. Over the year, however, the total income I’d receive should be around £1,200 — or £100 a month.

Roland Head owns Imperial Brands and Unilever. The Motley Fool UK has recommended Diageo, Imperial Brands, and Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.