I recently read that “passive income is the fuel that powers your dreams, giving you the freedom to pursue your passions and live your life on your own terms”. I have no idea who came up with this quote, but I hope they dream well and are in a position to spend their time doing something fulfilling.
Another investing concept that gets a good press is compounding. In the case of income stocks, this is the act of reinvesting dividends to buy more shares, generating an ever increasing level of return. This has been described as the eighth wonder of the world.
Just imagine how happy we could be by combining the two! Well, that’s what I try and do.
Now, I must be honest. I still have to work for a living and I’d love to have more freedom to do what I want. But I do have a steady stream of passive income that I’m reinvesting with a view to having a more comfortable retirement.
Take two
If I were to start my investing journey all over again, I’d put a relatively modest amount (say £100) into UK income stocks. If I then received dividend payouts of 5.9% a year — payable two-thirds/one-third in January and July, respectively — my hypothetical sum would grow to £67,248 after 25 years.
At this point, my shareholding would be generating income of £3,967 a year.
Readers may be wondering why I’ve chosen such specific numbers. Well, that’s because National Grid (LSE:NG.) presently offers a 5.9% yield and pays a dividend twice a year.
And it’s a share that has a long track record of increasing its payout.
My example assumes zero growth in its dividend. However, factoring in an increase of 3.6% a year — the company’s average annual increase over the past five years — would increase my investment pot to £131,731. This could give me an annual passive income of £7,772.
Remember, there could be some capital growth too.
Caution
Of course, the stock price could fall. And dividends are never guaranteed. But this example highlights the potential long-term gains achievable from picking a steady and reliable income stock.
National Grid is able to pay a generous dividend because its earnings are reasonably secure. It operates in a regulated industry, which means as long as it keeps the lights on (literally), it will be able to achieve a pre-agreed level of return.
Because of this its share price performance tends to be unspectacular. This — along with the fact that it’s the UK’s 13th-largest listed company — is why I describe it as a sleepy giant. I think there’s always room for this type of stock in a well-balanced portfolio.
But there are a couple of things that could threaten its ability to maintain its healthy dividend.
Although it doesn’t face any competition it must meet its regulatory obligations. This requires huge capital expenditure.
It surprised shareholders in May by asking them for more money. Due to the company’s large borrowings, perhaps its directors felt they had no alternative other than to approach its owners for additional cash. I wonder if the terms offered by lenders were unfavourable.
However, despite these challenges, the next time I’m in a position to invest I’m going to seriously consider taking a stake.
The post No savings? I’d put £100 a month into this sleepy giant to generate passive income of £7,772 a year! appeared first on The Motley Fool UK.
Pound coins for sale — 31 pence?
This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!
Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.
What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?
See the full investment case
More reading
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After a turbulent few weeks, could I be tempted by the National Grid share price?
New to investing? These are 2 of my best UK shares to buy to kick start a portfolio!
How I would generate £10,000 passive income from this utilities stock
James Beard 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.
