£5,000 in savings? Here is how I would invest in income shares

This Fool has been searching for ways to generate a passive return via income shares.

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The FTSE 100 has recently reached a record high. This might seem like good news all around, but it can actually make it harder for income investors to find high-yielding shares.

With inflation heading lower in the UK, dividend shares are becoming more attractive than alternative investments such as UK gilts, which have been returning mid-4% annually for different durations.

So, I thought I would examine two companies that I like for allocating capital to income shares.

British American Tobacco

British American Tobacco (LSE: BATS) operates in the… well, you guessed it, the tobacco industry. It sells products all around the world, managing a more diverse operation than that of its peers.

There are some macro headwinds for the company. It is working hard to keep selling a lot of traditional smoking products, like cigarettes and cigars, in its biggest market, the United States. In other countries, things are looking brighter. There’s also some hope that BAT’s efforts to do better in the US are working. For now, these traditional products are still the most important way the company makes money, so if sales keep going down, it could make investors feel even worse.

But BAT is making a strong transition to ‘Building a Smokeless World’. This vision aims to move 50% of revenue to non-combustible products by 2035. Although this is a large change for the company, it places it in a strong position to lead the way in a transitioning industry.

As far as income from investing in shares, British American Tobacco boasts a 9.37% dividend yield.

Legal & General (LSE: LGEN) is a major player in the insurance and investment industries, offering a wide range of services in both areas.

The increase in interest rates has been causing some problems for the investment management division’s assets, but the situation is getting better. On the bright side, the higher rates are actually helping the larger pension businesses.

The UK market is well established, but L&G is also expanding into other countries like the US, Canada, and the Netherlands. There are about $6trn in pensions in these markets, with only a small portion managed by insurers. This means L&G has a lot of room to grow.

It’s important to note that L&G has a strong solvency II ratio, which shows how well capitalised it is. Even though it dropped a bit last year, it’s still well above 200%, which is a good sign of financial strength. Also, L&G is making more money than it’s paying out in dividends, which supports a potential yield of 8.18%.

A good balance

If I were to allocate £5,000 to an account to generate some passive income, splitting a portfolio across British American Tobacco and Legal & General offers me a high passive return (at 8.77%, more than double the 3.5% of the FTSE 100 and higher than UK gilt investments) and allows me to invest in companies that I think can do well in the coming years.

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.

Jesse Williamson does not currently own any shares in the companies mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. 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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