The ASX share market is a perfect place to find investments that pay passive income. But there are a few different factors to consider.
Some investors prefer to buy only large ASX blue-chip shares, such as Commonwealth Bank of Australia (ASX: CBA), BHP Group Ltd (ASX: BHP) and Woolworths Group Ltd (ASX: WOW).
However, if investors want a significant allocation of large-cap shares, I think they should consider gaining a bit more diversification through a single investment in the Vanguard Australian Shares Index ETF (ASX: VAS).
Investors can build a portfolio of businesses that provides better growth and stability, and that's what I'm aiming for.
Decide what sort of portfolio you want
Focusing solely on high-yield ASX shares is a valid investment strategy. However, the risk of companies cutting their large payouts can be higher. High yields may also suggest that companies aren't investing as much in their businesses, leading to slow (or no) growth.
If I'm focused on income, I want to have a high level of confidence that payouts will continue flowing to me, particularly in a downturn. A recession is exactly when I may need those payments the most.
I'd rather invest in a company with a lower dividend yield and a better chance of dividend growth and stability. Don't forget that rising dividend payments can effectively offset inflation.
Passive income yield
It could be a good plan to have a general idea of what dividend yield you're targeting.
While yield shouldn't be the main (or only) focus, it's possible with different stocks to target a yield between 3% and 6%, depending on your income objectives.
We can mix and match different investments with different yields to create the desired average yield for the portfolio.
For example, a $20,000 portfolio with a 5% dividend yield would create $1,000 of annual dividend income. But, if someone wanted a higher yield, say 7%, that would translate into $1,400 of passive income.
ASX dividend shares I'd go for
I'm personally aiming for investments that can provide steady dividend growth and deliver capital growth over time.
That's why I own businesses like Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), Brickworks Limited (ASX: BKW) and L1 Long Short Fund Ltd (ASX: LSF), which currently have grossed-up dividend yields of 3.7%, 3.3% and 5.1%. I think those yields could be materially larger in three years, hopefully with share price growth, too.
We can also boost the dividend yield by adding one or two high-yield names. For example, Shaver Shop Group Ltd (ASX: SSG) has a grossed-up dividend yield of 11%, and WAM Microcap Limited (ASX: WMI) – another share I own – has a grossed-up dividend yield of 10.5%.
Soul Patts is one of my favourite dividend shares, and I appreciate the yield and small-cap exposure that owning WAM Microcap shares can bring.
Splitting $2,000 between those two ASX dividend shares would create an average grossed-up dividend yield of just over 7%. This shows how mixing low yields and high yields can still create a solid overall yield.
Other names I'd consider for a $20,000 passive income portfolio include Wesfarmers Ltd (ASX: WES), Rural Funds Group (ASX: RFF), Centuria Industrial REIT (ASX: CIP), Metcash Ltd (ASX: MTS), Telstra Group Ltd (ASX: TLS), Universal Store Holdings Ltd (ASX: UNI) and Step One Clothing Ltd (ASX: STP).
