How I’d invest £20,000 to generate £1,000 in passive income

There’s more than one way to target £1,000 in annual passive income. Here’s how our author plans to do it over the next decade by investing in stocks today.

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.

Passive income text with pin graph chart on business table

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The annual limit for investing in a Stocks and Shares ISA is £20,000. With that, I think it’s reasonable to aim for £1,000 in passive income.

Over a decade, that’s £10,000 in total. There are a couple of ways that I could try to achieve this.

The first is by investing in stocks that have high dividend yields. This would involve trying to collect £1,000 each year for the next 10 years.

Alternatively, I could buy shares in companies that will grow over time. I’d receive less than £1,000 this year, but look to get more later on to reach £10,000 after a decade.

There are strengths and weaknesses to each approach. Which one is right for me?

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

High yields

To achieve £1,000 in annual passive income right now, I’d need a portfolio with an average yield of at least 5%. I’d look to do this with fairly traditional dividend stocks.

If I were taking this approach, I’d start with shares in Legal & General and British American Tobacco. Each of these has a yield above 5% and a strong record of dividend payments.

This would allow me to add in some other stocks that currently yield slightly under 5% but won’t bring down the average too much. Kraft Heinz and Citigroup fit the bill here.

For some diversification, I’d look to add Realty Income shares. The company leases retail properties and the stock comes with the benefit of paying its dividends monthly.

In my view, none of these companies is likely to grow its earnings substantially going forward. That’s the downside to this approach.

The advantage, though, is that this strategy allows me to reinvest dividends quicker. WIth this approach, I’d be able to reinvest £1,000 in the first year and start compounding my income.

Growth

Taking the growth approach would allow me to start with stocks with lower yields. But I’d be looking for businesses with characteristics closer to those of growth stocks.

A good place would be something like Diploma. The stock currently has a dividend yield of 1.9%, but it’s growing its distributions at 15% annually.

Other stocks I’d consider for this approach are Games Workshop, Experian, and Microsoft. None of these has an eye-catching yield today, but all are growing quickly.

This approach offers less opportunity to reinvest dividends, but it results in higher dividend payments over time. Diploma, for example, will have a yield on cost of 9% if it continues on its growth trajectory.

My plan

If I were looking to invest £20,000 today, I’d prefer the first approach. A steadier stream of income attracts me more at the moment.

A significant rise in interest rates might draw me towards the growth stocks as share prices fall. But for now, I like the first strategy.

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.

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Stephen Wright has positions in Citigroup, Experian, Realty Income, and The Kraft Heinz Company. The Motley Fool UK has recommended British American Tobacco, Experian, Games Workshop, and Microsoft. 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.

More on Investing Articles

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »

Investing Articles

Investing £5 a day could help me build a second income of £329 a month!

This Fool explains how £5 a day, or one less takeaway coffee, could help her build a monthly second income…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

2 FTSE income stocks investors should consider buying in April

Income stocks are a great way to build wealth. Our writer details two picks she believes investors should consider snapping…

Read more »