£5,000 in savings? Here’s how I’d aim to start making powerful passive income today

With a cash lump sum to invest, this Fool lays out how he’d start making passive income. He also details one stock he’d buy today.

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I think it’s smart to target investments that generate a passive income. As billionaire investor Warren Buffett once said: “If you don’t find a way to make money while you sleep, you will work until you die.”

If I had £5,000 stashed away, here are the steps I’d take to start making powerful passive income.

Maximising gains

£5,000’s a healthy amount to start with. But I want to make sure I can gain every advantage possible. That’s why I’d invest through a Stocks and Shares ISA.

It’s a great investment vehicle to maximise gains. Each year, every UK investor is given a £20,000 limit to use. There are many benefits to investing through one. The most important is that with the profits I make through my ISA, not a penny’s paid in tax.

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.

Targeting income

That may seem like a small gain but, over the long run, it can make a massive difference. But to ensure I made the most of it, I’d have to buy the right sort of businesses.

I’d target stocks that pay investors a high dividend yield. The FTSE 100 average is 3.9%. For me, I tend to look at stocks that yield 6%, or more.

I’d also have to do research. Dividends are never guaranteed. So I want to make sure that a stock’s payout is sustainable.

That’s why I like Footsie shares. They’re well-established businesses with proven business models and stable cash flows. Those are all green flags when it comes to paying a dividend to shareholders.

An example

Going on the above, it’s stocks such as Legal & General (LSE: LGEN) I’d target. Its share price is up 9.2% in the last 12 months. But trading on just 9.8 times forward earnings, I think the stock looks great value for money.

However, what draws me into Legal & General even more is its 8.1% yield. That’s the fifth highest on the Footsie. In the last decade, its payout has increased by 80.8%, from 11.25p per share to 20.34p last year.

That’s impressive. And it highlights the company’s progressive dividend policy. We’ve seen this in action more recently with its five-year cumulative dividend plan, which finishes this year. By then, it will have returned up to £5.9bn to shareholders.

I’m expecting some volatility with its share price in the months to come. Ongoing economic uncertainty’s led to some customers pulling their money from funds. Its assets under management have faltered as a result.

But as a strong business with a high yield, it’s companies like Legal & General I’d target.

Crunching the numbers

Assuming its 8.1% yield, £5,000 invested in Legal & General today would generate £405 a year in passive income. That’s not bad. But there are a few ways I can boost that.

Firstly, I can reinvest my dividends. If I did that, after 30 years I’d be earning £4,369 a year in passive income. My investment pot would be worth over £56,332.

If I were to add a further £100 monthly contribution, by year 30 I’d be making £16,114 a year in passive income. What’s more, my investment pot would be worth over £208,429.

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.

Charlie Keough has positions in Legal & General Group Plc. 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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