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Buying shares in proven blue-chip companies as a way to build passive income streams is hardly a new idea. But while it may lack novelty, that does not mean it cannot be a long-term money-spinner.
Here is how, starting from scratch today, someone could aim to build a £10,000 annual passive income by investing in FTSE 100 shares.
The long term can be an investor’s friend
In this example, I will presume that an investor can achieve a 6% compound annual growth rate. That is not far off double the FTSE 100’s current yield of 3.3%. But I do think it is a realistic, achievable goal.
If the investor puts £280 each month into a Stocks and Shares ISA (or a share-dealing account, come to that) and compounds it at 6% annually, after 24 years the portfolio will be worth around £175k. At a 6% dividend yield, that would produce an annual income of over £10k.
Is 24 years a long time to wait? It may seem like it. But I think an important element of any passive income plan is realism. This is not a get-rich-quick scheme. Rather, it is a serious approach based on investing less than £10 a day and letting the compounding effect of time create a five-figure annual income built around large blue-chip businesses.
One share to consider
As an example of the sort of FTSE 100 share I think an income-focused investor should consider, there is British American Tobacco (LSE: BATS).
Tobacco is a highly cash generative industry as cigarettes are cheap to make, addictive and expensive to buy (albeit much of that cost goes to the Exchequer, not the tobacco company).
British American is a massive cash generator and has increased its dividend per share annually for decades. Even though its share price has jumped 43% in the past five years, the FTSE 100 firm offers a dividend yield of 5.9%.
One big risk hanging over the sector is a declining rate of cigarette use. British American has tried to mitigate this by expanding its non-cigarette portfolio of tobacco products. It remains to be seen how profitable that may be over the long term.
Things don’t need to be complicated
Is British American a sure thing? No. Although I would be surprised if it does not keep pumping out dividends for years to come.
Some companies have obvious risks, while at others the potential pitfalls are less obvious. All shares carry risks though.
But by diversifying across a range of different companies, an investor can help reduce the risk any one business poses to their passive income streams. That is a simple but effective risk management strategy.
Sticking to FTSE 100 shares is also a simple way to buy into some of the nation’s largest businesses. They may not all do well, but I expect at least some of them will.
FTSE 100 companies are paying out tens of billions of pounds in dividends every year – and I expect that to continue over the long term.
