£5,000 in savings? Here’s how I’d aim to turn that into £1,000 of annual passive income

Charlie Carman outlines how investors may be able to generate passive income by investing spare savings in a reputable FTSE 100 dividend stock.

| More on:

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.

Earning passive income from the stock market is a popular way to secure financial freedom. But, what kind of shares could help investors like me achieve this ambition?

Fortunately, plenty of stocks listed in the FTSE 100 and FTSE 250 indexes distribute a portion of their profits to shareholders via dividends. Although no company’s cash payouts are guaranteed, many investors have successfully used dividend investing to amass substantial fortunes.

So, let’s explore how I could use a spare £5,000 to bag £1,000 in annual passive income by investing in one leading blue-chip dividend stock.

A juicy yield

News about AI stocks might dominate the headlines currently. However, income investors shouldn’t overlook more traditional businesses amid the hype. For instance, bank shares often pay healthy dividends.

Take HSBC (LSE:HSBA) for example. The FTSE 100’s largest bank measured by market cap offers a chunky 7.9% dividend yield at present. What’s more, the lender’s forecast yield is even higher at a whopping 10.7%! This is a stock that merits serious consideration in my view.

Quick mental arithmeticians will notice that a £5k investment in HSBC shares would only yield £535 a year in passive income. So, how could I reach my coveted £1k figure?

Well, at The Motley Fool, we advocate taking a long-term approach to investing. Using HSBC’s forward yield, by pursuing a dividend reinvestment strategy, I could expect my shareholding to yield a four-figure sum in just over six years.

Granted, that assumption rests on the 10.7% yield remaining unchanged over the time period, which may not happen in reality.

However, I’ve also not accounted for potential growth in the HSBC share price. Accordingly, my journey to a £1k passive income stream could take more or less time, depending on how the shares fluctuate in value.

Understanding the risks

Like any stock, HSBC carries risks. On the bright side, the bank posted a record annual pre-tax profit of $30.3bn in 2023 — a 78% rise on the previous year. This headline figure looks impressive, but it’s worth digging deeper into the detail.

The final quarter was a challenging one. A $3bn charge on its stake in a Chinese bank dealt a nasty blow. As a result, HSBC missed analysts’ expectations for a full-year pre-tax profit of $34bn.

There’s also good reason to exercise caution about the dividend. Forecast cover of 1.6 times earnings is below the two times level that’s traditionally viewed as a comfortable margin of safety.

Nonetheless, the stock’s forward price-to-earnings (P/E) ratio of 6.4 is below the FTSE 100 average. This bodes well for future growth prospects. It also suggests many of the risks the bank faces are reflected in today’s share price.

Diversification

A good way to mitigate portfolio risk is diversifying across different companies and sectors. Indeed, there are many other high-yield UK stocks for investors to choose from.

Some examples to consider might include British American Tobacco with a 10.1% yield, insurance provider Phoenix Group Holdings with a 10.6% yield, and NextEnergy Solar Fund with a 10.9% yield.

By building a solid portfolio of dividend shares comprised of HSBC and the likes of those listed above, earning a healthy passive income stream is a realistic (albeit not risk-free) ambition that investors can consider.

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.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Charlie Carman has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. and HSBC Holdings. 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

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

Investing freedom — but inside a pension

Strapped consumers might be cutting back on investing, but they’re still keeping up their pension contributions. The only problem? A…

Read more »

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper
Investing Articles

Forget gold! I’d rather buy these 3 FTSE high-yielders in a Stocks and Shares ISA

Gold looks like a risky investment to me as the price hits an all-time high. I'm ignoring the fuss to…

Read more »

Young female business analyst looking at a graph chart while working from home
Growth Shares

This 55p UK stock could rise more than 300%, according to a City broker

This UK stock has fallen from above 800p to below 60p. But analysts at Citi believe it’s capable of a…

Read more »

Businesswoman analyses profitability of working company with digital virtual screen
Investing Articles

I think this FTSE 250 trust has all the right ingredients to lock in long-term profits

Today I'm examining the prospects of a private equity investment trust on the FTSE 250 that caught my attention recently…

Read more »

Young black man looking at phone while on the London Overground
Investing Articles

2 under-the-radar UK shares investors should consider snapping up

Two UK shares have caught the eye of our writer. She explains why investors should be taking a closer look…

Read more »

Investing Articles

Are these 2 ultra-high-yielding income stocks a good buy for me?

These two income stocks often split the debate amongst investors. So what does our writer think of them as potential…

Read more »

Senior woman potting plant in garden at home
Investing Articles

5% yield! This dividend stock could be great for my retirement

Our writer explains why this dividend stock appeals to her as she’s investing to build wealth to enjoy in the…

Read more »

A young Asian woman holding up her index finger
Investing Articles

I’d aim for a second income of £1,000 a month with this super-reliable dividend stock

I think a great way to build a second income stream is by investing in dividend stocks via a Stocks…

Read more »