Want passive income? Here’s how to invest for it

Investing doesn't have to be all about buying and selling. Rather than waiting for a big payout, income investors seek to regularly get paid through dividends.

If you own shares in a company listed on the stock market, you’re entitled to receive a share of any dividend income it pays out. This is usually paid twice a year, although some companies issue dividends quarterly or monthly.

Last year was a good one for dividends from UK companies: firms dished out £90.1bn worth of dividends, according to data provider Computershare, up from £88.8bn in 2023.

A similar dividend total is expected for 2025, as UK companies have already rewarded investors £14bn during the first quarter.

Here, Which? explains how to craft a portfolio that pays out year after year.

Please note: the content contained in this article is for information purposes only and does not constitute financial or investment advice.

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Spotting reliable dividend payers

UK dividends are heavily concentrated within the FTSE 100, amounting to about £78.5bn last year, according to AJ Bell. 

HSBC was the UK’s leading dividend payer (£12.1bn), helping to make the banking and finance sector the UK’s most generous dividend-paying sector for the second year in a row. 

Bumper dividends from oil giant Shell (£6.8bn), consumer goods multinational British American Tobacco (£5.2bn) and mining corporation Rio Tinto (£4.2bn) also boosted the overall figure.

Industries with the highest dividends

Dividends are never guaranteed, however, and can be cut or cancelled. Look at the key metrics that your investment platform is likely to display:

Dividend yield

Huge dividends might grab headlines, but a company’s dividend yield is what matters. This ratio shows how much it pays out in dividends each year relative to its share price. It’s calculated by dividing the amount paid out per share by its price. So, a £100 share paying a £3 dividend has a yield of 3%.

High dividend yields may be attractive, but they may also come at the expense of the potential growth of the company, because money is being paid out that could otherwise be reinvested.

Cover ratio

This shows how affordable the dividends are for the firm. It’s calculated by dividing a firm’s earnings per share by its dividend per share. 

A low dividend cover ratio of one or less suggests dividends are vulnerable because the company is using most of its profits to pay for dividends. 

A figure of two or above is traditionally preferred, as it indicates that firms can continue to maintain dividends even during tougher economic conditions.

Balance sheet and cash flow

You should also familiarise yourself with a company’s underlying financial health when assessing the safety of any dividend. This includes annual profit or loss, earnings cover, debt and any reserve cash holdings.

• Find out more: How to buy shares 

Income funds and trusts

Some funds are deliberately set up to generate an income, rather than growth.

The benefit of choosing a fund over individual shares is that a fund tends to hold hundreds or even thousands of shares, which will reduce the impact of a firm deciding to cut or cancel dividends. 

However, you’ll have to pay an annual management fee, which can differ significantly from one fund to another.

While funds must distribute all the income they earn each year, investment trusts can retain some of this cash, building up dividend reserves. They can then use this to provide payouts to investors when the portfolio isn’t generating much money, offering a stable dividend over several years.

• Find out more: How to invest in funds

Looking beyond the FTSE 100

Although the majority of dividends on the UK market are generated by the FTSE 100, it can still be worth looking at other British companies.

Russ Mould, investment director at AJ Bell, says: ‘The yield on the FTSE 100 is higher than that of the FTSE 250, but there are some stocks in the mid-cap index that do pay a very plump yield, notably in the financial and real estate sectors.’

Europe also offers a potential hunting ground for adventurous investors, according to Keith Bowman, equity analyst at Interactive Investor: ‘Like the UK, sectors in Europe such as utilities, oil and gas, food and drink, and financial services may offer candidates. 

‘Eon sits on an estimated future dividend yield of around 3.8%. French oil and gas company Total Energies offer a forecast dividend yield of 6.2%.’

However, he warns that costs to invest may be higher than UK companies. 

Also note that some European countries tax dividends, even for assets in a stocks and shares Isa, leaving you to reclaim tax where a double taxation treaty exists. Investing in a UK-based fund that specialises in European stocks means that a fund manager takes care of the tax for you.

The US market doesn’t have the same reputation for dividends as the UK, instead mainly focusing on capital growth. 

Only five of the 'Magnificent Seven' tech stocks currently pay a dividend – Alphabet, Apple, Meta, Microsoft and Nvidia – and none of them yield more than 0.75%, well below the FTSE 100. Alphabet and Meta only started paying a dividend last year, while Amazon and Tesla have never paid one.

How to build a robust portfolio

Global events like Donald Trump’s Liberation Day tariffs can disrupt financial markets and impact dividends. 

Markets have since settled, but the volatility reinforces the point that diversifying your portfolio is key to weathering the ups and downs. This includes holding assets in different regions (keeping in mind that many FTSE 100 firms do business around the world), as well as investing in different industries. 

If you’re looking for income now, rather than a potential bargain that will only be realised in the future, consider avoiding ‘cyclical’ companies such as airlines. These firms do well in good times but underperform the market during tougher economic conditions.

Other asset classes, such as bonds, can also offer a regular income. They’re typically less risky than shares, and there are plenty of funds and trusts that specialise in bonds. 

Consider adapting your withdrawal strategy. Attempting to take the ‘natural yield’ – living off dividends without ever selling assets – is hard enough, even in good economic conditions. 

But even if you do limit asset sales to 3%-4% of your portfolio each year, the level advised to stop you running out of money in retirement, you need to take care.

Already, this year has seen share prices of otherwise solid firms plummet before quickly rebounding. So, think hard about which stocks you sell as part of your 3%-4%, to avoid selling any at the bottom of the market.

• Find out more: How to balance your investment portfolio