Whenever I write about passive income, the 1985 Dire Straits song ‘Money for Nothing’ pops into my head. Although the track was referring to getting paid for playing music, I think it applies to dividend shares too.
The regular dividends paid out to shareholders for owning shares are kind of like money for nothing. And when I think about retiring on just a basic State Pension, money for nothing sounds pretty good!
But how much would I need to be comfortable – and how many dividend shares could deliver those returns?
Calculating returns
Taking into account inflation and the cost of living, an average UK citizen would need approximately £3,333 a month in 20 years or so (or £40,000 a year).
Even with a yield as high as 10%, that would require £400,000. Since most portfolios seldom achieve higher than a 7% average yield, it would need to be closer to £570,000.
By investing approximately £500 a month and reinvesting all dividends, it could take approximately 27 years to reach that amount.
A strategy
The good first step in this strategy — if not done already — would be to open a Stocks and Shares ISA. The tax benefits of an ISA can greatly maximise returns over the long run.
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The next step would be to build a diversified portfolio of high-yielding dividend stocks. With the right mix of stocks yielding between 5% and 9%, an average yield of 7% is achievable.
The problem is, unreliable stocks can lead to volatile yields, so it’s important to pick the right ones.
A good start is to look at the company’s track record of making payments. The best income-focused companies make their shareholder returns a top priority, and the track record shows.
A stock to consider
One stock for income investors to consider is the FTSE 250 specialised financial services group TP ICAP (LSE: TCAP). It has a 7% yield and has been paying dividends for over 20 years.
The company does a good job of balancing payouts with funding operations, ensuring the business runs smoothly. Even if profits slip, it has more than enough cash to keep covering dividends.
But like many income-focused stocks, it doesn’t experience much price appreciation — the shares are up only 30% in five years. However, with such a generous dividend, that’s sufficient as far as I’m concerned.
Helping to reaffirm its dividend sustainability, it has a healthy balance sheet showing a meaty £7.48bn in assets and comparatively low debt.
However, as always, there are risks. There’s a possibility that some of the company’s brokerage services could be rendered obsolete by AI. Although it’s working to adapt the business to meet these challenges, it’s too early to know how things will pan out.
Plus, as a key player in international markets, its profits are sensitive to volatility, inflation and interest rate changes.
Final thoughts
Typically, investors focus on large-cap FTSE 100 stocks for passive income. But in my opinion, TP ICAP stands out as a rare example of a smaller business offering long-term income stability.
To reduce risk, income investors typically build a diversified portfolio of 20 or more stocks, with some defensive and growth shares for balance.
