If I wanted to invest £100 to build a passive income, my first port of call would be high-yielding income shares.
I could pick up my phone and start today, and modern low-fee apps make the process as simple as ordering a couple of pizzas.
And with income shares, I receive the income on autopilot. In other words, I wouldn’t need to waste hours tinkering once it’s set up.
I’ll explain the downsides of this approach too, but first, let me explain what kind of investing this is.
Increasing income
Income shares are those from companies that regularly pay out a piece of their profits – usually in the form of a dividend.
One example is FTSE 100 insurer Legal & General (LSE: LGEN) – a £15bn value company with billions in sales each year.
As a mature, established company, much of its earnings (81% last year) goes directly to shareholders.
I own some of the shares already. I receive two payments per year and the next one will be sent on June 6.
And with the right company, these payments will get larger and larger. Legal & General paid an 11p dividend (per share) a decade ago but forecasts expect 21p and 23p for the next two years.
An increasing payment means my passive income potential grows the longer I hold the stock.
The dividend yield as I write stands at 8.09% – £8.09 if I were to invest £100.
I’m only a small-time saver, so 8% back is far better than my other options like savings accounts or a buy-to-let.
But even so, eight quid buys me a single pint these days – maybe with some crisps if I’m lucky. That hardly seems worth it.
Hefty returns
That’s because the compounding effect hasn’t got going yet. With more time and a slow drip-feeding of cash, I can target heftier returns.
Let’s say I put away £100 on a monthly basis. I’d put it all into a high-quality stable of stocks paying meaty dividends.
Every dividend I receive I’d plough straight back in to rev up the compounding effect.
Over time, I’d expect the compounding to pile up into a tasty nest egg. This is pretty much how people get rich investing. Slowly, but surely.
And if I like the sound of that, now might be a great time to start.
For one, stock market weakness has made British companies look very attractive. The average yield is nearly three times that of US firms.
Legal & General trades at 7.5 times forward earnings. That looks like a bargain to me and I believe there are plenty more out there.
Second, inflation is eating into cash. A decade of 5% inflation would mean that £100 has buying power of just £59.
Risks
But there are risks too. Income shares weren’t so hot during the pandemic as companies slashed payouts.
I can try and avoid duds with careful research. Legal & General was one stock able to increase payouts throughout those Covid years.
This increasing dividend along with one of the higher FTSE 100 yields makes it a strong hold in my portfolio.
But whether it’s my first £100 or my hundredth, high-quality income shares like this are my favourite recipe to build wealth and passive income.
