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How I aim to create a passive income of £5k a year

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I think investing in stocks and shares is one of the most straightforward ways to earn passive income. 

I’m not just saying it as I’ve put my money where my mouth is. I’m investing my hard-earned cash in a portfolio of stocks and shares, aiming to generate a passive income of £5,000 a year. 

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Today I’m going to explain the strategy I’m using.

Passive income strategy

I have set an initial goal of £5,000 a year because I believe I can accomplish this in the next few years. 

To hit this annual income level, I think I will need to build a portfolio worth between £100k and £130k. The reason why I’ve used such a broad range is that dividend income can be unpredictable. 

At the time of writing, the FTSE 100 supports a dividend yield of around 2.9%. However, some companies in the index, such as Phoenix Group, yield as much as 6%. Other stocks, such as Just Eat, yield nothing. 

My strategy is to target a range of companies with high and low dividend yields. There’s a simple reason I’m using this approach. A high dividend yield can be a sign that the market believes the dividend is not sustainable. Therefore, by investing in a range of businesses, I reckon can build in a level of income protection to my portfolio. 

Of course, I can only try to build in some protection. Dividends are never guaranteed.

For example, last year, many FTSE 100 companies decided to eliminate their dividends to save cash in the coronavirus crisis. These sort of one-off risk events are entirely unpredictable. They’re something all investors have to be prepared to deal with at some point.

Other challenges such as rising interest rates and higher operating costs may also lead to reduced dividends.

A basket of stocks

The companies I’ve bought and plan to buy for my passive income portfolio are spread across a range of different sectors and industries. 

In the property sector, I currently own shares in regional office provider Regional REIT. The stock offers a dividend yield of around 7% at the time of writing. 

In the FMCG sector, I own shares in Unilever. This consumer goods champion offers investors a dividend yield of 3.5%. 

I also own British American Tobacco and plan to buy Phoenix Group. These companies offer some of the highest dividend yields in the FTSE 100. That could make them a bit riskier than Unilever and Regional, but I’m comfortable buying both businesses at current levels.

I also plan to acquire the City of London Investment Trust. I think investment trusts can be an excellent way to gain exposure to a portfolio of income stocks at the click of a button.

Due to the way trusts are structured, they can also hold back revenue in good years to cover dividend payouts in bad years. This is an advantage other investment funds do not offer. That’s why I would buy this investment trust with its 4.9% dividend yield today.

That’s the strategy I plan to use to hopefully generate a passive income of £5,000 a year. Of course, I know it’s not guaranteed and these aren’t the only stocks I plan to buy as I think there are plenty of other businesses on the market with fantastic dividend potential. 

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Rupert Hargreaves owns shares in Regional REIT, Unilever and British American Tobacco. The Motley Fool UK has recommended Just Eat Takeaway.com N.V. and Unilever. 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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