£20K of savings? I’d use that to target £1,600 of extra income every year

If our writer had £20,000 to invest today and wanted to target an extra income of £1,600 each year, this is the approach he’d take.

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.

pensive bearded business man sitting on chair looking out of the window

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.

With interest rates moving up, it is now possible for some savers to earn a decent return on money in a savings account. Still, if I had a lump sum and wanted to use it to generate extra income, I would rather put it into shares given some of the bargains available in today’s market.

Buying shares carries risks that putting money into a bank account typically does not. But I think I could earn more income putting money into the stock market than a savings account, even allowing for such risks.

If I had a spare £20,000 of money today I wanted to put to work, here is how I would target annual extra income of £1,600.

Setting some ground rules

Although I am willing to tolerate some risk, that does not mean I want to act rashly. Quite the reverse, in fact.

So my first move would be setting some rules for myself about how to invest when trying to earn extra income. Every investor is different, as each has their own circumstances.

For me, I would stick to well-known companies from the FTSE 100 and FTSE 250 indices.

I would limit my search to companies with a track record proving they have had a profitable business model that funded high dividends. That is not necessarily an indicator of what may happen in future. But making profits can be harder than it looks, so I would prefer to invest in firms that have already demonstrated they can do it.

To reduce my risk, I would diversify across different companies and sectors. £20,000 is enough to let me spread the money evenly over five to 10 companies. My focus would be squarely on businesses I understood.

Another consideration would be how much spare cash I expected a firm to throw off even after paying for things like capital expenditure and debt repayment.

A company like 10.5%-yielding Vodafone can generate a lot of free cash flow – but its capex needs and groaning balance sheet could yet pose a risk to the dividend.

Building the portfolio

So, what sorts of shares might I buy?

My target of £1,600 in annual extra income implies an average dividend yield of 8% on my £20,000.

That is only an average, though. So if I buy some shares yielding 8% or above, I could also purchase some with a lower yield.

Right now, a number of FTSE 100 shares I own yield more than 8%. Examples include British American Tobacco, Legal & General and M&G.

Others I would consider adding to my portfolio if I had a spare £20,000 include Phoenix and Aviva. Of those, only Aviva yields less than 8% — and it is still on an impressive 7.8%.

Looking at that list though, financial services dominates. In building a portfolio I would want to stick to my diversification principle. High yields in financial services could signal a risk that a weakening economy leads to falling customer demand and lower profits.

With careful research and investing, I think my £1,600 annual target could be achievable.

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.

C Ruane has positions in British American Tobacco P.l.c., Legal & General Group Plc, and M&g Plc. The Motley Fool UK has recommended British American Tobacco P.l.c., M&g Plc, and Vodafone Group Public. 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

Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.
Investing For Beginners

After getting promoted from the FTSE 250, what’s next for Hiscox?

Jon Smith mulls over the latest reshuffle in the FTSE 250 and explains why he feels this top stock could…

Read more »

Investing Articles

Want dividend yields up to 9.9%? Here’s 3 FTSE 100 and FTSE 250 shares to consider

Looking to turbocharge your passive income? These high dividend yield FTSE 100 and FTSE 250 stocks could be just what…

Read more »

Investing Articles

2 shares absolutely crushing the FTSE 100 in 2024!

Not all FTSE 100 stocks are sleepy and meandering. This duo has surged more than four times higher than the…

Read more »

Silhouette of a bull standing on top of a landscape with the sun setting behind it
Growth Shares

The FTSE 100 could hit 9,000 points by year end. Here’s why

Jon Smith talks through some factors that could help to lift the FTSE 100 to a new all-time high and…

Read more »

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

I’d seriously consider buying this UK technology small-cap stock today

Today's positive trading figures and a runway of growth potential ahead make this small-cap stock look attractive to me now.

Read more »

Investing Articles

It’s October! Does this mean UK stocks are going to crash?

Whisper it quietly, but four of the five biggest one-day falls in the FTSE 100 have been in the month…

Read more »

Investing Articles

With new nuclear energy deals in view, Rolls-Royce’s share price looks cheap to me anywhere under £11.48

Rolls-Royce’s share price dipped after a problem on a Cathay Pacific flight but has now bounced back on positive news…

Read more »

Investing Articles

Is the Greggs share price now a screaming buy for me after falling 10% this month?

Harvey Jones watched the Greggs share price climb and climb, but decided it was too expensive for him. Should he…

Read more »