Investors looking to generate passive income from FTSE 100 shares might wonder how much capital they need to hit their target. So let’s crunch the numbers.
Generating a second income of £777 a month would add up to £9,324 a year. That’s would give the State Pension a handy boost.
The amount of capital required to produce that income depends on the yield of the investor’s portfolio. I believe it’s reasonable to aim for an average yield of 6% from a diversified mix of UK dividend stocks. Under this assumption, an investor would need a total of £155,400 invested to reach their goal.
FTSE 100 stocks pay heaps of dividends
That sounds like a hefty sum, but it can be built over time. Someone investing £200 a month could surpass this milestone in 25 years. Sounds too slow? Then invest more.
Assuming an average total return of 7% a year, they could potentially amass £162,423. That’s roughly in line with the long-term FTSE 100 average total return, which combines both capital growth and reinvested dividends. Buying individual stocks can potentially offer a superior return, plus more income (albeit with more risk).
British American Tobacco (LSE: BATS) has long been a favourite for income seekers to consider. The cigarette giant may be operating in a declining industry, but it remains highly profitable and continues to reward shareholders with generous dividends.
Its shares have surged 33% over the last year. However, the stock’s seen plenty of volatility, and despite this recent surge, it actually trades at similar levels to three years ago.
The company’s full-year 2024 results, released on 13 February, disappointed the market, putting an end to its recent stellar share price run.
Profits from operations grew a modest 1.4% to £2.7bn, but free cash flow before dividends shrank 5.5% to £7.9bn. The board only hiked the dividend by 2% to 240.24p per share. At least it increased it though.
It isn’t risk-free
There are risks. The tobacco industry remains under constant regulatory pressure, and British American Tobacco faces tough competition from global giants such as Philip Morris and Imperial Brands.
Crucially for income investors, the stock offers a highly attractive dividend yield of 7.45%. It also trades at a relatively modest price-to-earnings ratio of 8.7 and I feel it’s worth considering.
Some people won’t want to invest in tobacco stocks and I totally get that. I don’t. But there are loads more FTSE 100 shares that offer both growth and dividends. I suggest building a portfolio of at least a dozen, and probably around 15-20, to spread risk.
Generating £777 a month in passive income is achievable with a patient, long-term approach. Better still, it should rise over time, as companies increase shareholder payouts. Most aim to do that every year, provided they generate enough cash to do so. No guarantees though.
Our investor shouldn’t just stick to tucking away £200 a month. They should aim to increase that in time to keep pace with (or beat) inflation, and throw in lump sums when they have money to spare.
The more they invest, the more financial freedom they’ll have in later life, thanks to the twin miracles of compounding and passive income.
This post was originally published on Motley Fool
