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By making smart decisions in the stock market, investors can immediately start earning a second income through dividends. And for those lucky enough to already have a chunky £250,000 sat in the bank, deploying this capital in the market today could instantly unlock a dividend income between £8,000 and all the way up to £21,000.
Here’s how.
Dividends from the FTSE 100
With UK shares reaching record highs this year, the dividend yield offered by FTSE 100 index funds is a bit lower than usual at around 3.2%. For reference, the long-term average is closer to 4%.
Regardless, that means anyone who puts £250,000 to work inside a low-cost index tracker will automatically start earning around £8,000 a year in passive income. And since an index fund is highly diversified, the risk associated with this income’s relatively low.
Dividends can, of course, be cut. But looking at the history of payouts from fund providers like Fidelity or Vanguard, ignoring the impact of the pandemic, shareholder payouts have, overall, been trending upward.
That’s certainly an encouraging sign for long-term sustainability. And having an extra £8,000 roll in each year is nothing to scoff at. But by taking on a bit more risk with a stock-picking strategy, this income can be drastically improved.
Aiming higher
While the FTSE 100 as a whole may only offer 3.2% right now, there are still some constituents offering significantly more impressive yields. And Phoenix Group Holdings (LSE:PHNX) sits among the most generous, with an 8.4% payout.
At this rate, a £250,000 investment would generate a second income of £21,000 overnight. But of course, this doesn’t automatically make it a good investment because, as previously mentioned, dividends can get cut. So how sustainable is this lofty yield?
The insurance and pension product enterprise has benefited enormously from higher interest rates. This macro metric has significantly increased the popularity and attractiveness of financial instruments like annuities, enabling Phoenix to deliver impressive double-digit earnings growth.
With more money flowing to the bottom line, dividends have followed while regulatory coverage ratios have simultaneously improved. In other words, the balance sheet has strengthened alongside its cash generation capacity. And subsequently, the payout ratio remains firmly below 100%, signalling strong dividend sustainability.
Needless to say, that’s definitely an encouraging sign. So why aren’t more investors rushing to buy?
Incoming headwinds
Despite the impressive recent performance, the group’s outlook is somewhat uncertain. Steady interest rate cuts throughout 2026 and beyond ultimately reduce the appeal of new annuity products. As such, future growth’s expected to be far more challenging.
There are also ongoing regulatory risks. A change in capital requirement rules could constrain profit distribution, handicapping dividends and buybacks. And combining all this with ongoing economic deterioration, once-bullish investors are growing increasingly more cautious surrounding life insurance businesses.
This is why Legal & General, as well as M&G, also currently offer impressive yields right now.
The bottom line
Historically, it’s the contrarian investors who have made some of the biggest gains. And if Phoenix Group’s able to navigate through the shifting macroeconomic environment, delivering on its cash generation targets, considering the shares today could mean phenomenal long-term passive income.
However, that’s a big ‘if’. And investors will need to carefully evaluate the execution risk that this enterprise faces.
