Passive income: how I’m going to invest for an extra £1,000 a month

Just after the start of the 2021/22 tax year in April, my family will receive a hefty, but somewhat unexpected, windfall. It’s not an inheritance and no-one’s died, thank goodness. This windfall will arrive as several cash lump sums from various investments and payouts. It’s complicated to calculate, but the final total could be around £300,000 after tax. My aim is to use this sum to generate more passive income for my family.

What is a passive income?

Passive income is ‘unearned earnings’ — money that comes from sources other than paid work. Examples of passive incomes include savings interest, bond coupons, share dividends, rental income, and income from other assets. One low-risk option would be to put the whole lot on deposit and just collect the savings interest. But with rates so low, a savings rate of, say, 1% a year would generate only £3,000 a year. This would be taxed at the 40% rate, producing £1,800 a year after tax. This extra £150 a month in passive income really isn’t going to change our lives.

Another choice might be to invest the money in government and corporate bonds. These IOUs pay a regular income (known as coupons) and then return the initial capital on maturity. But bonds have been in a 40-year bull market where prices have soared. Thus, most bonds today are more expensive than at any point in history. With safe bonds yielding 1% a year or less, but at much greater risk than savings deposits, today’s bonds are too high-priced for me.

I’ll invest in quality UK companies

My wife and I have decided to use this windfall to generate extra income to meet steeply higher household expenses. My son was a university fresher last autumn and may need four years of funding. Likewise, my daughter starts university next year to train as a doctor, which might entail five to seven years of funding. Their combined bills for accommodation alone will easily exceed £1,000 a month, hence our need for extra passive income.

Our goal is fairly undemanding: we want to generate 4% a year from this capital, generating £12,000 in passive income (before tax). To do this, we plan to invest in shares of high-quality companies that pay decent cash dividends. At the moment, the FTSE 100 index has a dividend yield of 3% a year. Thus, to get 4%+ in yearly dividends, we will focus on higher-yielding shares.

Right now, more than 20 different FTSE 100 shares pay yearly dividends of 4% or more. The average dividend yield across these Footsie stocks is almost 5.8% a year. Thus, investing £15,000 in each of 20 different blue-chip stocks would capture a decent chunk of the FTSE 100’s dividend stream. Then again, just 10 FTSE 100 stocks generate more than half of all the dividends paid by the Footsie. Hence, our focus will be on these and other dividend dynamos for passive income.

One final word: we can afford to take stock-market risk with this £300k windfall, as we already have a large, balanced, long-term portfolio of assets. Therefore, we won’t worry too much as share prices rise and fall. Just so long as this extra passive income stays stable or rises over time, we’ll be happy with our new income portfolio. And any future capital gains will be a welcome bonus!