The Motley Fool

How I’d invest £3,000 now in UK shares to make a passive income

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Tired woman sleeping on London underground
Image source: Getty Images

Passive income is money that one receives without working for it. That might sound unbelievable, but it happens all the time. Rental fees, royalty payments, and share dividends are all examples of passive income streams. One might not have the money to buy a property to rent out, or have the talent to write music that could generate royalties. But investing money into high income shares is a way to generate passive income even with a relatively small amount of money to start.

Diversification helps reduce risk

£3,000 is enough to invest in more than one share. In fact, it is enough to invest £1,000 in each of three different companies. I prefer that approach as it diversifies my portfolio. That helps reduce risk, in case one of the companies cuts their dividend or meets some unforeseen challenges in its market. But diversification can also help when it comes to timing passive income.

5 Stocks For Trying To Build Wealth After 50

Markets around the world are reeling from the coronavirus pandemic… and with so many great companies trading at what look to be ‘discount-bin’ prices, now could be the time for savvy investors to snap up some potential bargains.

But whether you’re a newbie investor or a seasoned pro, deciding which stocks to add to your shopping list can be a daunting prospect during such unprecedented times.

Fortunately, The Motley Fool UK analyst team have short-listed five companies that they believe STILL boast significant long-term growth prospects despite the global upheaval…

We’re sharing the names in a special FREE investing report that you can download today. And if you’re 50 or over, we believe these stocks could be a great fit for any well-diversified portfolio.

Click here to claim your free copy now!

Different companies pay out dividends on different schedules. If I invested £3,000 in one share, I’d only get the income when it paid out its dividend. By investing in different shares, I could get income at different times from the various companies. Some companies pay dividends four times a year. If I invested in three different companies each paying their four quarterly dividends in different months, I could even end up receiving some passive income every month.

Higher dividends are good for passive income

With passive income as my investment objective, I wouldn’t pick shares that don’t pay out dividends. That actually rules out a lot of fast-growing shares such as S4 Capital and The Hut Group. That’s because companies that are growing fast often prefer to reinvest spare cash into the business to fuel further growth. Companies that pay out a high percentage of their earnings as dividends are often in more mature industries, such as mining or consumer goods. They often see marginal returns into ploughing more cash back into long-established businesses, so they pay out spare cash to shareholders as dividends.

I would start by looking at a list of the highest yielding shares. Yield is more important to me than the absolute dividend size. The yield is the percentage of my capital I would expect each year as income. It’s similar that way to an interest rate. By contrast, a dividend that looks high might not make me much passive income if the shares are also highly priced, pushing its yield down.

Then I’d look to see how sustainable the dividends looked. For example, does the company generate enough cash to cover it and will that continue to be the case? Business can meet unexpected difficulties, so there is always a risk dividends can be cut. But I prefer investing in companies that are highly cash generative and are set to continue that way, like Unilever or British American Tobacco.

I’d also look at the dividend history, to see whether the company has a history of increasing its dividend. British American Tobacco has raised its dividend annually for a couple of decades. That might not continue, but if it does, it could be an agreeable source of passive income.

FREE REPORT: Why this £5 stock could be set to surge

Are you on the lookout for UK growth stocks?

If so, get this FREE no-strings report now.

While it’s available: you'll discover what we think is a top growth stock for the decade ahead.

And the performance of this company really is stunning.

In 2019, it returned £150million to shareholders through buybacks and dividends.

We believe its financial position is about as solid as anything we’ve seen.

  • Since 2016, annual revenues increased 31%
  • In March 2020, one of its senior directors LOADED UP on 25,000 shares – a position worth £90,259
  • Operating cash flow is up 47%. (Even its operating margins are rising every year!)

Quite simply, we believe it’s a fantastic Foolish growth pick.

What’s more, it deserves your attention today.

So please don’t wait another moment.

Get the full details on this £5 stock now – while your report is free.

christopherruane owns shares of British American Tobacco and S4 Capital plc. The Motley Fool UK has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Our 6 'Best Buys Now' Shares

Renowned stock-picker Mark Rogers and his analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply click below to discover how you can take advantage of this.