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The British stock market is home to a collection of excellent passive income stocks. In fact, several FTSE 100 shares pay some of the most generous dividends worldwide. And building a diversified portfolio of these top-notch businesses is a proven method to earn money without having to work.
With the 2022 correction sending some valuations down the drain, dividend yields have shot up. And while the UK’s flagship index has since recovered, plenty of solid constituents are yet to climb.
That means shrewd investors have a rare window of opportunity to secure a potentially lucrative dividend from UK shares. Even more so, given that analyst forecasts predict 2023 and 2024 could be record years for FTSE 100 dividend payments.
Building a big passive income
Looking at the historical performance of the FTSE 100, it has, on average, delivered a total annual return of around 8%. Investors can instantly replicate this performance by simply buying shares in a low-cost index fund. Investing £500 a month at this rate of return would potentially lead to a £1m portfolio within 34 years (although that’s not guaranteed, of course).
That’s quite a nice nest egg to retire on. For younger investors, it could even mean an earlier retirement. And given the FTSE 100 has an average dividend yield of 4%, once the million-pound threshold has been reached, an individual could choose to withdraw their dividends, leading to a passive income of £40,000 a year.
But there’s a potentially even more lucrative alternative. Instead of buying an index tracker, investors could opt to pick individual UK shares. The risks are obviously much higher, and a lot more due diligence is required. After all, putting sub-par stocks into an investment portfolio is arguably one of the fastest ways to set money on fire.
However, stock picking done well opens the door to market-beating returns. And even if it’s just by an extra 1%, the same level of monthly investment over the same period could build an investment portfolio worth £1.34m. That’s the equivalent of an annual passive income of £53,600.
UK shares have their risks
As exciting as the prospect of becoming a millionaire and never working again sounds, there are some significant caveats to consider. Firstly, historical performance is a relatively poor indicator of future results. Just because the FTSE 100 has generated 8% in the past doesn’t mean it will continue to do so. And it’s entirely possible that future returns will be lower.
The same applies to picking individual UK shares. Building a custom portfolio of even the best British businesses can be a significantly more volatile experience, especially when a crash or correction inevitably rears its ugly head. And depending on the timing of these events, an investor’s passive income stream after 34 years could be significantly smaller than expected. Having said that, given the potential rewards, these risks are worth taking, in my opinion. And the sooner an investor starts, the closer they could potentially get to their goal of financial independence.