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One way of earning a second income is by investing in a fund that aims to match the FTSE 100. That’s worked well over the last few years, with the UK index up 60% since 2020.
Right now, the index comes with a 3.17% dividend yield. But I think passive income investors might be able to do even better by looking at some specific names.
Dividend yields
A 3.17% dividend yield means an investor needs a substantial portfolio to earn £1,500 a month in passive income. Specifically, the figure is £567,900.
That’s assuming the investment is in a Stocks and Shares ISA to avoid dividend tax. But a £20,000 annual contribution limit means building something that big takes time.
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Over the long term, the average annual return from the FTSE 100 has been just above 6.5%. At that rate it would take 15 years of investing the full contribution to reach £567,900.
That might seem like a long time, but investing’s a long-term activity. And these numbers mean someone ‘only’ has to invest is only £300,000 – the other £267,900 comes from the returns.
Aiming higher
Doing better than the stock market is difficult. But it isn’t impossible and there are things investors can do to give themselves a chance of achieving higher returns.
One of these involves trying to figure out which businesses will do best over time. And in the case of the FTSE 100, this might be companies that are currently outside the index.
A good example is Diploma (LSE:DPLM). The company only joined the FTSE 100 in 2023, but it has kept up the impressive growth that’s seen it move up through the FTSE 250 since 2019.
That coincides with the arrival of Johnny Thomson as CEO. And a combination of acquisitions and organic growth has meant the stock’s climbed over 133% in the last five years.
Industrial distribution
Diploma’s a distributor of industrial parts and equipment. And that means there’s always a risk of manufacturers trying to go directly to their consumer base and bypassing the company entirely.
That however, is easier said than done. The FTSE 100 firm’s scale allows it to operate with speed and efficiency – and this is something individual manufacturers can’t easily replicate.
With a 1.13% dividend yield, Diploma doesn’t look like an obvious passive income stock. But the company’s rapid growth means it deserves attention from investors.
The firm has more than doubled its dividend in the last five years, so investors who bought in 2020 are getting over 2.6% a year. And while it gets harder to grow quickly the bigger it gets, I think it still has a way to go.
Thinking long term
In a world where some stocks have dividend yields above 7%, Diploma probably doesn’t feature on the radar of many passive income investors. But I think anyone with a long-term focus should check it out.
The company has a strong balance sheet, a competitive position that’s hard to disrupt, and a powerful business model. That could well generate higher dividends for investors over time.
As well as looking at the stock, I think investors should also be on the lookout for the ‘next Diploma’. And it’s worth remembering that one might be a name that hasn’t reached the FTSE 100 yet.
