Collecting passive income via dividends from UK shares is a popular strategy. But does it work?
This back-test suggests it can.
Two popular dividend companies
For this experiment, I’m looking at two FTSE 100 stocks: financial services company Legal & General (LSE: LGEN) and energy transmission and distribution operator National Grid (LSE: NG).
However, all stocks and businesses carry risks as well as positive potential. So, in reality, it’s important to diversify invested money between several stocks and not just two.
That’s standard advice and it applies to dividend strategies as much as it does to any other investment approach. Big dividends in themselves will not save investors from losses if a stock turns out to be a duffer. Directors can slash dividends, share prices can plunge, and company profits can disappear in a puff of smoke.
That’s not the kind of outcome wanted for half the money in a portfolio. So, in an effort to reduce that risk, I’d target the shares of at least five different dividend-paying companies and ideally more than that.
A decent overall gain
Nevertheless, five years ago, National Grid’s share price stood near 850p and today it’s in the ballpark of 1,005p. So that’s a gain of 155p per share.
Shareholders have also collected dividends worth almost 255p per share over the period.
By adding the two figures together, the total gain over the past five years has been around 410p per share. Or to put it another way, National Grid has delivered its shareholders a 48% return over the past five years.
Meanwhile, Legal & General’s share price was about 259p five years ago. Today it’s close to 239p. So that’s a loss of 20p per share.
In this case, dividends have saved shareholders from an overall loss.
The company delivered 90.49p in dividends over the period leading to a total return of 70.49p per share for investors. That works out at just over 27%.
If I’d taken an initial £7,000 and split it equally between these two stocks five years ago, what would my overall investment be worth now?
Ignoring trading costs, £3,500 invested in National Grid would now be worth about £5,180 including the dividends collected. Meanwhile, £3,500 invested in Legal & General would have turned into around £4,445.
Reinvesting dividends for compounding
My overall initial investment of £7,000 would have risen to £9,625 including those all-important dividends – a gain of 37.5%. Considering all the economic and geopolitical challenges that have occurred since the 2019 start date, that’s a pretty good result.
However, it would have been possible to juice-up the gains a little by reinvesting the dividends along the way rather than taking them in cash. That would enhance the process of compounding, which is key to building wealth.
Some share account providers will automatically reinvest dividends back into a company for a low fee. I’d be inclined to take advantage of that kind of service when operating a passive dividend-led investment strategy.
I’m encouraged by this outcome and keen to find some more decent dividend-paying companies to add to my portfolio.
