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Investors can build a brilliant second income stream by investing in the shares of dividend-paying FTSE 100 companies, in my view.
Even if the investor doesn’t need the income today, it’s still worth doing. Instead of drawing the dividends, they can simply plough them back into their portfolio to help their money compound and grow.
They can eventually take the dividends as passive income to top their State Pension and other savings when they retire. And it’ll be tax free.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Tuck money away tax free
Every year, UK adults get a £20,000 ISA allowance and they can invest all of it in stocks and shares, if they wish. Most of us can’t afford to tuck away that much each year (I’ve never come close). But by investing as much as we can each year, and sticking at it for decades, the wealth can still roll up.
The FTSE 100 boasts some stunning dividend yields today. Housebuilder Taylor Wimpey (LSE: TW.), for example, has a brilliant trailing yield of 8.04%. That’s roughly double what savers can get on cash today, although the two aren’t strictly comparative.
With cash, capital’s safe. That’s not the case with shares. Capital can fall if the company’s share price slides (although it may also rise).
The Taylor Wimpey share price has been going the wrong way lately, falling 20% in the last year. Higher inflation and mortgage rates have squeezed property demand. At the same time, inflation has driven up the cost of materials, and wages too.
This has squeezed margins, and the government’s Budget hikes to employer’s National Insurance contributions and the Minimum Wage have also driven up Taylor Wimpey’s costs.
The shares now look decent value though, trading at 14 times earnings. And when inflation and interest rates finally fall, they may come roaring back – with luck. They’re worth considering but nothing’s guaranteed.
A handy bit of dividend income
Taylor Wimpey’s dividend looks reasonably solid, despite that dizzying yield. If it holds, investors should get a steady stream of passive income while they wait for the shares to kick on.
Over time, I’d look to build a balanced portfolio of shares like this one, ideally around 15. That way if one struggles, others may compensate.
Let’s say an investor tucked away £5,000 of their Stocks and Shares ISA allowance each year, and generated an average total return of 7% a year, after charges. That’s roughly in line with the FTSE 100 long-term average.
If they stuck at that for 30 years, they’d have £505,356. That’s only a benchmark as everything depends on how well their stocks perform in practice. They could end up with less, they could get a lot more.
Now let’s assume their portfolio yields 5% on average, and they took all their dividends as income at retirement. That £505,356 would deliver income of £25,268 a year, without touching any of the capital, which would be free to grow.
Obviously, that’s a tad hypothetical. But it does show how FTSE 100 dividends can build wealth over time, starting from nothing. It won’t happen overnight though. It takes time and dedication. But the results may be well worth it.
