The FTSE 100 is home to plenty of solid, dividend-paying shares. But to build a reliable passive income, I’d want to find the very best ones to invest in. So what makes a good dividend share?
A good dividend share
Firstly, I’d say a good dividend share should offer an above average dividend yield. Currently, the average dividend yield in the FTSE 100 is around 3.5%. So I’d be looking for shares that offer more than this.
Next, I’d like to find stable and reliable dividend-payers. I reckon a company that has been paying dividends for 20 years might be more reliable than one that has only recently started.
Lastly, I’d want my FTSE 100 companies to be able to afford paying dividends from their earnings. If a company isn’t earning enough, it might not be able to continue paying me a dividend.
FTSE 100 top picks
There are several FTSE 100 shares that meet my criteria. And as some sectors tend to outperform others at varying points in the business cycle, I like to have some variety in my selections.
Telecoms giant Vodafone offers a 7% dividend yield and has been paying out dividends for 29 years. That’s quite some track record, in my opinion.
Insurance firm Aviva has a similarly long history in dividend payments to shareholders. What I also like about Aviva is that its dividend payout is well-covered by its earnings. This gives me some comfort that the current level is sustainable.
Rio Tinto is a global mining giant that not only offers a reliable 7% dividend yield, but offers a growing, high-quality business. I reckon due to its exposure to commodities, it also offers some protection against rising inflation.
Factors to think about
Some points to note, however. The above three stocks all have their risks and challenges. Their dividends aren’t guaranteed. Just because a company has paid dividends for many years doesn’t automatically mean it will continue to do so. Earnings could be affected by currently unknown factors. And if earnings fall, dividends could be at risk.
Another factor to think of when looking at passive income is that share prices can fall as well as rise. To receive a relatively stable income from FTSE 100 shares, I’d ideally want to my shares to rise or at least stay flat.
Passive income pot
In order to build a £10,000 passive income, I calculate that I’d need a pot of at least £167,000. And that’s if I can find shares that consistently offer 6% dividend yields. Bear in mind though, if my average yield drops to 5%, I’d need around £200,000.
I reckon that’s doable. Especially if I have many years before I need to access the passive income. Regular investing over decades, and the power of compound interest, can generate a surprisingly large pot.
The FTSE 100 is a great place to look for quality dividend-payers. It certainly has several companies that warrant further research. But I have to say that for building a share-based passive income pot, I’d use my tax-efficient Stocks and Shares ISA. I wouldn’t want to pay out any of my gains in tax.
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Harshil Patel has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
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