I think investing in stocks and shares is one of the most straightforward ways to generate a passive income. With that in mind, here are five stocks I would use with the goal of generating a passive income of £10,000 a year.
Building a portfolio
I’m targeting an average portfolio yield of around 4%. Based on this target, I estimate I will need a savings pot of £250,000 to generate a passive income of £10,000 a year.
I’m not just going to buy any old dividend stocks for my portfolio. Dividends are never guaranteed, which means investors have to be careful when selecting dividend stocks. A high dividend yield can be a sign the market does not believe the payout is sustainable.
So, instead of buying the highest dividend yields for my portfolio, I would buy a mixture of companies. I think this strategy could provide me with a sustainable passive income and the potential for income growth, as well as some protection against dividend cuts.
Passive income investments
The first place I would look for income is the utility sector. Here I would buy National Grid and United Utilities.
National Grid operates the UK’s electricity infrastructure, while United Utilities is a water provider. Both of these businesses are highly defensive. That means there’s a steady stream of income available for these firms to support their dividends.
Both sectors are also highly regulated. As such, regulators have a lot of control over how much profit these companies can return to shareholders. Unfortunately, this may hurt their ability to increase their payouts in the long run.
Still, with dividend yields of 5.8% and 4.4%, respectively, I think these companies would make great additions to my passive income portfolio.
Another company I would buy for my income portfolio is the banking giant Lloyds. As it stands, the stock currently supports a dividend yield of 1.3%. However, that is expected to increase to 3.7% next year, and I think further growth could be on the cards, although it’s not guaranteed.
Another coronavirus wave could cause significant loan losses at the lender, which would inhibit its ability to increase its distribution. Still, considering its income growth potential, I would add this stock to my passive income portfolio.
A company with a market-beating dividend yield I’d buy is insurance group Phoenix. This stock currently supports a dividend yield of 6.7%. As this income is derived from the management of pension assets, which can be a very steady business, I think it looks attractive. Nonetheless, the organisation may have to rethink its dividend plans if there’s a sudden increase in interest rates, which may upset its balance sheet.
The final stock I’d buy for my passive-income portfolio is LXI REIT. This company invests in commercial property assets with very long leases stretching up to 30 years. A high-quality tenant portfolio means the group collected 99.8% of its rent for the second quarter of 2021. This high rent collection should support the REIT’s dividend yield, which currently stands at 4.2%.
However, as this is backed by income from property, management may have to reduce the distribution if rental income slumps, which it may do in a sudden economic downturn.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.