£10k in savings? Here’s what I’d do to target a passive income of £500 per month

Our writer shares how they would invest in dividend stocks in an attempt to turn their savings into a reliable passive income stream.

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If I had £10,000 in savings and was looking to generate a reliable passive income stream, there are several options I could choose from. For example, I could invest in buy-to-let property or even buy some government bonds.

But while both of these approaches represent tried and tested methods for earning a second income, I think a superior strategy is to invest in dividend shares.

With that in mind, here’s how I’d use high-yield income stocks to aim to transform £10,000 in savings into £500 a month in passive income.

The advantages of buying shares

Many established UK companies distribute regular dividends to shareholders, providing investors with a steady income stream. And in my view, investing in dividend stocks to earn passive income offers several advantages compared to other approaches.

First and foremost, unlike, say, buy-to-let properties, investing in dividend stocks doesn’t involve rigorous property management. Moreover, it comes without the hassle of tenant issues and maintenance tasks.

In this way, it’s a very hands-off investment. After all, it allows me to earn passive income without the day-to-day involvement required with a property.

Additionally, by investing in shares I can diversify my £10,000 in savings across various sectors and industries. This is significant because diversification spreads risk by providing a buffer against poor performance in a particular sector. This simply isn’t possible with concentrated investments like buy-to-let properties.

That said, while dividend stocks offer several advantages, it’s crucial for me to remember that they also come with risks. For instance, market fluctuations can impact share prices and affect the value of my investment. Alternatively, economic downturns can sometimes lead companies to cut or suspend dividends, thereby impacting my income stream.

A dividend stock at the top of my watchlist

That’s exactly what happened with financial services provider Legal & General during the 2008 financial crisis. Thankfully, since then, the group’s long-term business prospects have changed for the better.

To illustrate, the company now benefits from a healthy financial position and a reliable global customer base.

On top of this, that 8.8% dividend yield is extremely appealing. While dividends are never guaranteed, the group’s handsome yield provides me with the prospect of a substantial cash flow.

Harnessing the power of compound returns

So, how exactly could buying shares in companies like Legal & General turn my savings into a second income worth £500 a month? The answer is thanks to the miracle of compounding returns.

Let’s say I used my initial £10,000 investment to buy a diversified basket of dividend shares that yielded an average of 8%. After reinvesting the dividends and allowing them to compound, I’d reach a portfolio earning over £500 per month in dividend income after 27 years.

Now it’s pretty clear that this approach requires a long-term horizon and mindset, both of which are crucial to building serious wealth in the long run.

But by investing regularly with monthly contributions on top of my initial £10,000 investment, I could potentially reach that goal in a reduced timeframe.

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.

Matthew Dumigan has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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