I believe owning income stocks is one of the best ways to generate a passive income. Indeed, this is an approach I already use. I have been investing a few hundred pounds a month to build a portfolio of dividend shares that have the potential to provide a steady stream of income.
The one downside of using this approach is that dividend income is never guaranteed. Dividends are paid out of company profits. Therefore, if profits collapse, management may have to cut the payout.
Even after taking this risk into account, I’m comfortable using this strategy to generate a passive income. And I’m targeting an annual passive income of £1,000 a month.
Passive income stocks
A couple of approaches are available to investors who want to buy stocks for a passive income portfolio. They can either purchase equity funds, investment trusts, bond funds or stocks and bonds directly.
I’ve been using the direct approach. I’m acquiring a basket of income stocks, which I believe have attractive passive income credentials. However, buying single stocks can be a precarious income approach. As such, I’ve been buying a diversified portfolio of shares.
At one end of the portfolio, I’ve been buying high-income FTSE 100 stocks. Some examples include Persimmon and British American Tobacco. These shares could yield as much as 8% in the year ahead, according to analyst estimates.
I’m also looking at BHP and Rio Tinto. These are more of a short-term investment. Both companies are currently profiting from record-high commodity prices. These have helped them generate vast amounts of cash, and they’re returning a large chunk of these excess profits to shareholders. Rio recently announced its largest-ever dividend.
While these yields are attractive, I’m well aware commodity prices can fall as fast as they rise. It’s unlikely these record payouts will last forever. Still, I’d like to make the most of these companies’ good fortunes in the meantime.
Middle of the road
As well as the high-yield stocks outlined above, I’ve also been buying companies with lower yields. While not always the case, it’s often true that firms with lower yields have lower payout ratios. Therefore, there’s more room to increase the dividend in the long term. I think this is a good trade-off for a passive income portfolio.
Some examples of these companies I’ve been buying include Diageo, Unilever and Reckitt. All of these firms yield 2% to around 3.5%.
I think real estate investment trusts (REITs) also have a place in my portfolio. While commercial property values have taken a hit recently, companies are restoring their dividends.
The most prominent REITs I’ve been buying are Landsec and British Land. These stocks are projected to yield 3.7% and 2.8% respectively.
I’m targeting a 4% yield on my portfolio. According to my figures, this means I’ll need to put away £300,000 to generate an income of £12,000 a year, or £1,000 a month. Given plenty of time and using the above approach, I think it could be possible for me to hit that target.
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Rupert Hargreaves owns shares of British American Tobacco, British Land Co, Diageo, Landsec, Reckitt plc, and Unilever. The Motley Fool UK has recommended British American Tobacco, British Land Co, Diageo, Landsec, 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.