Turning £10k of savings into £13k of passive income? Here’s how I could do it

Jon Smith explains how he can build a reliable source of passive income from dividend stocks, and shares one of his favourites to include.

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The concept of having cash savings in the bank is appealing because it feels safe. Yet if that money is surplus to my needs and isn’t generating any form of return, I need to do something about it.

That’s why I prefer to invest my savings in ideas that can make me good levels of passive income. One example is putting money to work via the stock market.

Things to do (and avoid)

The general principle of making income via the stock market comes from utilising dividend stocks. These are shares that pay out dividends to shareholders, usually a couple of times a year. So if I can have a portfolio of around a dozen stocks, I should be receiving some form of income every month.

The big question revolves around which dividend stocks to buy. After all, there are hundreds of different ideas to choose from. Even within the FTSE 100, the range on the dividend yields goes from 0% to above 10%.

I like to target the upper range with yields around 6-8%. This is because it’s higher than the current base rate of 5.25%. Also, there’s a good mix of companies that have a yield in this range. When I start to look at the 10%+ area, there are only a few stocks that meet this criteria.

Further, the higher the yield, the more risky it becomes. In some cases, the yield’s only this high because the share price has been falling rapidly. This isn’t sustainable for the long term, so I prefer to give that a pass.

A good inclusion

As a good example of a stock I own, consider Rio Tinto (LSE:RIO). I bought the mining stock early in the year thinking that it gives me good exposure to commodities. After all, I believe several key commodities could do well going forward.

This includes copper, which Rio Tinto mines for. There’s a huge commercial need for copper, which contributes to the electric vehicle (EV) motors and batteries. Another angle is iron ore, which Rio Tinto is a leader in producing. This is used in steel and so is sold to places like China that is a manufacturing powerhouse.

The business is doing well, with the stock up 4% over the past year. The dividend yield is 6.62%, so in the target yield bucket I want. From looking at the finances from the past few years, Rio Tinto has always been clearly profitable. Therefore I don’t see a risk that it falls to a loss and has to completely stop paying out a dividend.

One risk is that lower demand from China could be seen as their economic recovery continues to be shaky. This would negatively impact iron ore sales.

Making the cash

If I took my £10k in savings and invested it in a portfolio with an average yield of 7%, my pot would grow. If I kept reinvesting the dividends I receive, it helps to grow the dividends further down the line. After 12 years, I could have received £13.1k just from dividends. In year 13, this could be an additional £1.7k.

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.

Jon Smith owns shares of Rio Tinto 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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