With almost a whole year stretching ahead, now can be a good time to focus on personal finances. One of my goals this year is to increase my income. An obvious way to do that could be by working more hours. But another is to generate passive income from shares.
Here is how I could try to go about that, sticking to blue-chip FTSE 100 shares.
Why the FTSE 100?
With a universe of shares open to me, why would I focus on the FTSE 100 index of leading UK shares? After all, alternatives include investing in the US market, or buying into smaller British companies.
In fact, I do both of those things already, so I do see their possible role in an investment strategy. But I also own a number of FTSE 100 shares and plan to buy more this year.
These companies tend to be well-established, blue-chip firms. I know that because the index is basically arranged by size. Broadly speaking, it contains the 100 London listed firms with the biggest market capitalisations on a certain date.
Size is not always an indicator of quality. But broadly speaking I do think that if a company has been around for many decades and continues to operate at scale, it is probably doing something right. I would say that description covers many FTSE 100 shares, such as Shell, Unilever and Lloyds Bank.
However, while membership of the index is an indicator of size, that in itself does not make a company a good fit for my portfolio, especially if my focus is income.
Finding income shares to buy
For that, I would narrow my search within the index. I would look for businesses I understood, as that would make it easier for me to assess their prospects.
My passive income idea is to generate dividends. For a company to do that, it needs to throw off surplus cash it does not need in its business. So I would look for a company I thought had a unique competitive advantage in a sector with resilient demand. That could let it generate surplus income, which might be paid as dividends.
Unilever is an example. Its collection of premium brands gives it pricing power. The company pays a quarterly dividend.
The role of yield
Dividends are never guaranteed, so I would never put all my investment funds into one company such as Unilever. Instead, I would spread it across a variety of firms.
How much I could earn depends on the average dividend yield of the shares I buy. That is basically the amount of dividends I should earn in a year, expressed as a percentage of what I pay for the shares. The Unilever yield is 3.5%. That is okay, in my opinion, but other FTSE 100 shares offer substantially higher yields.
I would try to maximise my income – but smartly. So I would not just plump for the highest-yielding shares. Instead, I would consider the overall quality of a company and the value offered by its share price. Prospective dividend yield would just be one consideration among others.
