Investors are getting more and more interested in passive income today. By passive income, we mean income generated by owning shares that pay dividends. This is both a great way to grow your investments over time, assuming you reinvest your dividends into more shares, or simply a way to boost your normal income.
Luckily, the UK stock market is full of companies that pay very healthy dividends! These so-called ‘value’ shares are not always popular with investors who want the high growth potential of tech stocks, but over the long run, the passive income they can generate is considerable.
In this article, we take you through a few ideas for how you can use £10,000 to get passive income from UK shares.
Which Sector to Invest in?
The first question to answer is which sector tend to have companies paying good dividends? This is usually called the dividend yield, and it varies a lot from company to company. However, it is definitely possible to generalize about different industries. Tech stocks, for example, tend to have very low dividend yields. These companies may be growing very fast, and are using all their retained earnings to grow further. On the other hand, more traditional and less cutting-edge companies probably have higher dividend yields but lower overall growth potential.
If you are hunting for passive income, then it is all about dividend yields! Buy large, well-established companies that have proven track records of paying good dividends over many years. These companies probably have dominant positions in their industries and business models that have stood the test of time. They will never double in size like a smaller tech company might, but they will be very likely to hold their value and growing dividends over the years.
There are several sectors of the UK market that fit this description, but for me, the best place to invest £10,000 in UK shares to earn passive income is with banks and other financial companies.
Banking is a cyclical sector. This means that when the economy is booming, the banks do very well, and when the economy busts, the banks suffer. That said, over several cycles the banks have shown that they have the resilience and adaptability to tough out the bad times and come back strong in the good times. Plus, no matter how bad a recession is, it is very unlikely we will all shred over credit cards and stop using banks and their services!
As such, many UK banks represent great opportunities to earn steady dividends over the years. In fact, the passive income potential of banks is now much higher than many other sectors, hence their popularity with Warren Buffet. Well run banks can and do generate great dividend yields, and are where I’d look for passive income from the UK markets.
Some UK financial firms well-known for paying chunky dividends include household names like Lloyds and Aviva. Lloyds currently yield 2.66%, which is a good level in its own right, but prior to Covid this number was more likely to be around 5-6%. Analysts expect the shares to regain this level as the economy continues to normalize. In 2020, insurance group Aviva’s shares yielded an awesome 8.3%. This was an especially good year, but normally they can be expected to offer around 5%.
Some investors hungry for growth might be put off by these high payments, saying the companies should be using their profits for growth rather than paying money out to shareholders. However, for large, established firms like these which have good positions in their markets, there is a strong case to be made for rewarding shareholders. Likewise, for those seeking passive income, there is a strong case to be made for including these and other UK financial companies in your portfolio.
Known around the world as the sponsor of Liverpool FC, Standard Chartered currently only yield 1,4%, but pre-Covid this number was usually closer to 3%. Not stellar in the world of UK banking dividends, but very respectable. Finally, less well-known merchant banking group Close Brother’s shares currently yield 3.6%, down from 5% in 2019. The UK banking universe is full of companies who have long term records of paying good dividends come rain or shine.
What about the Future?
However, there is another reason to invest in the UK financial sector. For those seeking passive income in the years ahead, as well as dividend yields today you also have to pay attention to the growth prospects of the whole sector. On this front, the future looks very bright for UK banking.
The City of London and the Coming ‘Digital Big Bang’
Post-Brexit, the UK government has made keeping London as a world-leading financial hub a top priority. For decades now, finance has been the best performing sector of the UK economy. The government has commissioned a report authored by Ron Kalifa, a former chief executive of Worldpay. This set out a roadmap to ‘digital Big Bang’ which will keep UK banks thriving in the years ahead. One of the key areas highlighted in the report is the need to continue reforms to facilitate innovation. The so-called ‘fintech’ sector promises to turbocharge long-run growth for financial firms, and this is something UK banks can take advantage of. Given that much of this innovation is happening in London, this suggests UK firms can continue to lead the way. Recent examples would be the IPOs of TransferWise and PenionBee.
Kalifa’s report also points out that Scandinavian pension and insurance firms greatly benefited from being early adopters of investing in off-shore wind farms. They made massive returns on these investments. Meanwhile, UK insurers weren’t allowed to invest as these new methods of energy production were considered too risky. The report argues a similar approach should be taken now, whereby insurers and pension funds are allowed to actively invest in the UK fintech sector, thus providing the capital needed for the fintech ecosystem to develop more rapidly.
All of this suggests UK banking stocks don’t just have good dividend yields today – they have long-run growth potential too. If you are looking to generate passive income from £10,000 in the UK stock markets, financial companies should definitely be on your watchlist!
eToro - Buy Top UK Shares with 0% Commission
eToro have proven themselves trustworthy within the stock market over many years – we recommend you try them out.
Your capital is at risk. Other fees may apply