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Forget the August Premium Bond draw! Here are 3 ways I’ll aim to get passive income from stocks

Every month, the Premium Bond draw from NS&I comes around. The August Premium Bond draw results are just out. It’s a mix of playing the lottery with a protected initial investment, hence why millions of Britons have them. Although the safety of having the funds stored away in bonds is one selling point, a lot of investors use the premium bond draw for income. But with the chances of actually getting a meaningful amount from the bonds being slim, many should be looking to generate passive income from stocks instead.

Safe dividends

The main way investors get income from a stock is via a dividend. Firms pay out dividends, usually as a result of the profits earned from a trading period. Special dividends can also be paid during the year, if there are available funds from the sale of an asset or other cash injections.

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In order to warrant switching from Premium Bonds to stocks, we need to have certainty of income. This has become harder over the past few months given that many firms are cutting back on dividends to boost their cash levels. After all, the Covid-19 pandemic has hit most sectors to some degree. So I’d be making sure that I bought stocks that are still paying out dividends. Good examples I’ve seen recently are M&G and Legal & General.

Go high but not too high

Obviously you’ll be wanting to make your money work as hard as possible for you. Yet, just picking the stock that has the highest dividend yield in the FTSE 100 or 250 is not always the smartest move. Over the past 12 months, Evraz frequently was in the top five highest yields at well over 10%. Yet the share price halved during this period, and concerns over the sustainability of dividend payments has rightly been flagged by some. 

The August Premium Bond draw may earn me £0, but at the same time it isn’t going to lose my initial investment. So in order to reduce the risk of losing on your capital versus Premium Bonds, look for a dividend yield that is high, but sensible at the same time. Anything in double-digits at the moment would make me cautious about buying into the stock. 

Diversify

We all need to diversify our investments but having a chunk of your investment portfolio just in Premium Bonds isn’t that diversified. You aim to get some kind of income (with the average return being around 1.4%) but it’s all from the same source. With stocks, you can split up your investment into various different dividend-paying firms that are independent of each other (with the FTSE 100 average dividend-yield being 3.73%).

Even though your investment amount is the same as you would put into Premium Bonds, it’s more diversified. Having half a dozen firms in your portfolio that pay out dividends allows you to pick up more consistent income. Even if one firm stops paying out income due to Covid-19, your overall income stream shouldn’t be impacted too much.

One point I will stress is that dividend income from stocks doesn’t have the upside potential of making £1 million in one go. Yet only two people out of 21 million from the August Premium Bond draw got that kind of return. So really it makes sense to play the averages, and pick up passive income via stocks.

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jonathansmith1 has no position in any of the shares mentioned. 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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