There’s no ‘right’ way to make money in the stock market. However, one relatively fuss-free way of doing so is to focus on generating passive income. This can be achieved through buying stocks that pay dividends. Today, I’ll be looking at three approaches I could take if I were looking to invest £1,000.
1. Invest £1,000 in dividend stocks
One way to invest £1,000 for income would be to buy individual company stocks. Fortunately, there are plenty of UK shares offering bumper yields right now. FTSE 100 power provider National Grid returns 5.3%, for example. Insurer Legal & General yields 6.4%! That’s far more than I’d get from even the best Cash ISA.
There are other positives. One of these is the lack of ongoing costs. Once shares have been purchased, the only fees are those charged by the online platform investors use for maintaining their accounts.
That said, I think this is the worst way of generating passive income with £1,000. It simply isn’t cost-effective to build a portfolio of, say, 10 stocks with this amount of cash. Too much money will be taken up in commission costs when buying the shares.
This being the case, it probably makes more sense to buy, say, two or three stocks. A consequence of this approach, however, is that my money is now overly concentrated. In other words, I’m now dependent on a small number of companies sending me dividends. It’s the equivalent of placing all my eggs in too few baskets.
Thankfully, there are other options.
2. Buy an active fund
An alternative would be to invest £1,000 in an actively managed fund. This puts my money in a larger number of income-generating shares, thereby making it significantly less risky. If a few holdings are required to cut payouts due to poor trading, the remainder should offset this.
There are additional benefits to this approach beyond diversification. Having a fund manager work on my behalf would appeal to me were I a ‘hands-off’ investor. Theoretically, this person should be more skilled at selecting the best income stocks thanks to their knowledge and experience. Popular picks include the Threadneedle UK Equity Income (2.7% yield) and Jupiter Income (2.9% yield).
Unfortunately, a big drawback to this approach is the management fees. The more I have to pay out to the manager, the less income I’m able to enjoy (or reinvest).
3. Buy an exchange-traded fund
A final option for generating passive income — and my personal favourite for a pot of £1,000 — is to buy an exchange-traded fund. In contrast to those above, this kind of investment vehicle doesn’t require active stock-picking. Here, we simply track an index of stocks, such as the FTSE 100.
An exchange-traded fund doesn’t aim to beat the market. Instead, it provides the same return, minus fees. Importantly, it can also provide a dividend stream to investors. A drawback of this is that the yield won’t be as high as I might get from individual stocks (currently around 2.8%). However, the lower fees and ‘safety in numbers’ approach help to make up for this.
Of course, investment is never completely passive. This approach still requires me to select which fund to buy and which index to track. That index could also go through a rough time, temporarily reducing the value of my holding. Even so, I do believe this offers the best risk/reward trade-off if I were looking to invest £1,000.