How I’d invest £500 a month to achieve a passive income

This Fool highlights the stocks he’d buy today with an investment of £500 a month for a passive income portfolio of UK shares.

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I firmly believe buying stocks and shares is one of the easiest ways to generate a passive income. 

It’s also one of the most accessible ways to generate passive income, in my opinion. Indeed, anyone can buy stocks and shares with just a few pounds. Other strategies require thousands, or hundreds of thousands, of pounds to generate such an income. 

However, this strategy might not be suitable for all. Dividend income generated on shares is never guaranteed. Dividend income is paid out of profits. Therefore, if a company’s profits suddenly decline, management may have to reduce the payout. 

Still, I’m comfortable with the level of risk involved in buying stocks and shares for a passive income. And I think it could be possible to generate one with an investment of as little as £500 a month. 

This is the strategy I would use. 

Passive income strategy

An investment of £500 a month is not going to enable me to achieve millionaire status fast. Nevertheless, I think it will put me on the right path as this money will almost immediately start generating income. Moreover, by reinvesting it back into the market, I can create a virtuous cycle.

I would invest my £500 a month in a portfolio of blue-chip stocks. I would buy companies that have robust competitive advantages and strong brands. Some examples are Unilever, Diageo and BAE Systems. These stocks offer dividend yields of between 2% and 5%.

I believe that targeting a range of shares with different dividend yields is the right approach. Focusing exclusively on companies with high dividend yields may expose me too much risk. An unusually high yield can signify that the market does not believe the payout is sustainable, although it is not a guarantee. 

Some research shows that companies with lower dividend yields achieve better dividend growth in the long run, although once again, this is not a guarantee. 

Diversification

As well as the companies outlined above, I would also buy an investment trust for my passive income portfolio. 

The company I would focus on is the City of London Investment Trust. This trust owns a portfolio of income stocks and shares, which is managed by professional investment managers.

Not only does this provide a high level of diversification, but investment trusts have a unique trait, which can make them excellent income investments. They can hold back 25% of their revenue every year. This can then be used in periods when dividend income from the portfolio declines to fill in the gap. This came in particularly handy last year. 

The one downside of using this approach is that I cannot choose the investments in the portfolio. This could expose me to some companies I would rather not own. The trust could also underperform the market. 

Despite these risks and challenges, I think the trust would fit perfectly into my £500 a month passive income portfolio. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns shares of Diageo and Unilever. The Motley Fool UK has recommended Diageo and 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.

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