There are various ways that an investor can make passive income. Some might turn to the property market, buy bonds, or consider dividend shares from the stock market. I like the latter method for several reasons, including the ease of access and the risk-adjusted returns. Here’s how a £6k sum could be used to build an income portfolio.
Being active in stock selection
One idea would be to allocate £1k to six different stocks. This provides some diversification, meaning that the eggs aren’t placed in one basket. Therefore, if one company runs into difficulty and cuts its dividend, the portfolio can still function and generate income.
And having a specific selection of stocks also helps to enhance the portfolio yield versus passively using an index tracker that pays out income. For example, the FTSE 100 average dividend yield is currently 3.38%. I believe that with active selection, this yield can be doubled, without picking stocks that have major red flags.
Over time, the passive income should build up. Part of this comes through compounding, with dividends being used to buy more stock. This can allow the portfolio to grow at a faster pace than if the investor took each dividend and spent it.
Talking numbers
In terms of specific stocks, an investor could consider a mix of BP (LSE:BP), Land Securities Group, Aviva, WPP, Phoenix Group and Legal & General. The average yield from this group is 7.03%. This selection also benefits from being diversified at a sector level, with companies from a range of areas being included.
If an investor put £6k in and reinvested the dividends, the pot would grow over time. At the end of year 13, the portfolio could generate £1,008 just from dividend payments.
Taking the opportunities
Let’s focus on BP (LSE:BP). This is the riskiest stock I’ve included in the passive income portfolio. Over the past year, the price has been down 24%.
The stock has suffered due to the firm making strategy errors, such as generating losses from renewable energy projects. Net debt has also increased, currently sitting at £20bn, with tight cash flow contributing to this. Finally, the oil price has been trading lower, with it hitting 52-week lows in early May.
The move downwards in the share price has boosted the dividend yield. A year ago, it was around 5%, and it is now at 6.48%.
But I think this makes it a stock to consider right now, with a favourable outlook going forward. CEO Murray Auchincloss is now refocusing BP on its core oil and gas operations. He’s aiming to increase upstream production significantly in coming years, as well as targeting almost £10bn in debt reduction by 2027.
With this strategy shift under way, I think BP’s worst period is in the past. Therefore, thinking about adding it now while the dividend yield is elevated could be smart.
