Generating passive income is a goal that many British investors share. From retirees to younger investors, lots of people are looking to generate some cash flow from their investments.
While I’m not personally looking for income yet (I’m in the growth phase of investing), I often think about how I’d build a safe passive income stream if I was seeking cash flow, which is what a lot of investors are after. With that in mind, here’s a look at how I think they should go about investing £20k for income in 2025.
Straight into an ISA
My first suggestion would be to put that money into a Stocks and Shares ISA. The reason I’d do this is that any income generated within the account would be tax-free.
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.
Spreading my money around
Next, I think investors should look to spread their money out over a range of different dividend stocks. These give shareholders regular cash payments out of company profits.
Assuming they didn’t already own any income shares, they should probably look to put the £20k into 10 to 15 different stocks. If they owned this many stocks and a couple underperformed they’d probably still do okay.
Focusing on company fundamentals
In terms of how to choose the stocks, I’d look for a few things.
First, I’d suggest looking for companies with long-term growth potential. One thing I’ve learnt is that if you invest in a company with poor prospects, it often ends in tears, even if the dividend yield is originally attractive.
Next, focus on companies with high dividend coverage ratios. This ratio measures a company’s earnings per share against its dividends per share and it can indicate how safe a company’s dividend payout is.
Generally speaking, a ratio above two is great, while a ratio above 1.5 is acceptable. If a ratio is near or below one, it’s a red flag.
I’d also suggest looking for companies with solid balance sheets. If a company is saddled with debt, it can lead to a dividend cut because interest payments always take priority over dividend payments.
Finally, I’d generally avoid stocks with very high dividend yields (9%+). Often, a high yield is a warning sign of something wrong and a dividend cut ahead.
I’d focus on stocks offering yields of between 4% and 7%. These yields tend to be safer than spectacularly high ones.
A top income stock?
One stock that meets this criteria today is pharma giant GSK (LSE: GSK). As a developer of medicines and vaccines, I think it has significant potential in a world in which the population is growing and ageing.
And the income on offer looks attractive — the yield is just under 5%.
Meanwhile, dividend coverage is healthy. For 2025, earnings per share are projected to be 155p, easily covering the forecast dividend payment of 60p (a dividend coverage ratio of 2.6).
As for the balance sheet, it looks reasonable. Admittedly, it had net debt of £12.8bn at 30 September, but I think this is manageable.
Of course, this stock has its risks. One to consider is the appointment of RFK Jr as US health secretary (he’s a notorious vaccine sceptic).
Overall though, I think GSK has potential as a passive income play. For anyone seeking income, I think it’s worth considering.
