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There are various ways to earn passive income from FTSE 100 shares, and one relatively straightforward strategy is to pick ones paying high dividends. I’m thinking something like Legal & General (LSE: LGEN), which at the time of writing has the Footsie’s highest forecast dividend yield at 8.3%.
It means putting £10,000 into Legal & General at that dividend rate could mean pocketing £830 per year. And as part of a diversified long-term portfolio, that could make a very nice addition to our total income. But if we reinvest the cash each year in more shares, we could potentially build it up to a fair bit more than that.
Diversified rewards
Before we plunge into a few calculations, let’s think about this level of profit. Is it realistic to aim for 8.3% per year? After all, dividends aren’t guaranteed, and they tend to rise and fall over time. Legal & General itself is in a volatile sector, which can actually suffer some pretty tough years from time to time.
That’s where diversification comes in. We really need to spread our investments across a range of stocks in different sectors. And that will reduce the risks associated with any one company or industry. But doesn’t that mean we’re also diversifying away from the stocks offering the biggest rewards?
Long-term returns
Well, the average annual return from a Stocks and Shares ISA over the past 10 years came in at 9.6%. So that’s even better than the predicted dividend yield from Legal & General. It does include share price gains as well as dividend income. But when we’re building up a passive income share portfolio, it all counts equally. It’s total returns, with dividend cash reinvested, that adds up to make our eventual retirement pot.
If we look further afield and examine annual FTSE 100 returns, the total averages 6.9% per year over the past 20 years. Aiming to equal the 8.3% predicted from Legal & General dividends does seem feasible.
Compound magic
With time we can improve on a simple one-off investment. Buying more shares with each dividend payout could more than double our cash in 10 years, to over £22,000. And that could mean £1,800 annual passive income.
What if we could stash away an extra £200 per month? That could push our total pot after a decade as high as £59,000. And 8.3% of that each year would mean a £4,900 passive income. I’ve done calculations like these hundreds of times and I know what the results come out like. But it still brings a smile to my face every time.
Stock market risk
As well as the sector risk, Legal & General’s earnings currently don’t cover the projected dividends. But they should hopefully soon be sufficient. Still, I’d say insurance stocks are best avoided unless investing for at least 10 years.
But with that proviso, I strongly rate Legal & General as one to consider as part of a diversified passive income portfolio
