In the current interest rate environment, it might seem silly to suggest that I can earn £5,000 a year in passive income. However, I genuinely believe this is possible by investing in income stocks and building a steady stream of dividend income.
Unfortunately, it is a lot harder to earn income from the market than it used to be. As investors worldwide have been searching for a place to park their cash rather than in the bank, the market’s average dividend yield has fallen. Today, the FTSE 100 yields an average of around 3%. A few years ago, the yield was more than 5%.
Still, I think I can earn £5,000 in dividend income every year by picking high and low yield stocks.
Dividend income portfolio
To generate £5,000 a year, I reckon I would need an investment portfolio worth £111,000. This is based on an average yield target of 4.5%.
I think it might be possible to achieve an average yield of 5% or even 6% by taking more risk. I am not particularly comfortable with this strategy, which will certainly not be suitable for all investors.
That said, I am entirely comfortable owning a handful of high yield stocks in my portfolio, as this will offset some of the lower yielding equities.
The high yield stocks I would buy for dividend income are British American Tobacco and Phoenix Group. At the time of writing, these companies offer dividend yields of around 8% and 6%, respectively.
Some other higher yielding equities include Imperial Brands, which offers a yield of 9.2% and Evraz, which currently yields 11.6%. These yields sit at this level for a reason.
As a Russian steel producer, Evraz’s income is highly volatile, and the payout is always at risk. Meanwhile, Imperial’s bottom line has shrunk over the past few years. If it keeps shrinking, the firm may have to take an axe to its payout. I would avoid these companies for those reasons, although I would be happy to buy British American and Phoenix.
Growth and income
As well as these stocks, I would also include a selection of equities with above-average yields, including BAE Systems (yielding 4.7%), Moneysupermarket (yielding 4.6%), and Man Group (yielding 4.9%).
I would buy mid-cap income stocks for a bit more diversification and exposure to potentially faster-growing enterprises alongside these blue chips. Bellway (yielding 3.8%), 3i Infrastructure (yielding 3.7%), and Domino’s Pizza (yielding 2.5%) are all on my list.
An equally weighted portfolio of all of the above companies would yield 4.5%, producing dividend income of £5,000 a year from a £111,000 portfolio.
The one significant risk of using this approach is the fact that dividend income is never guaranteed. Companies can cut dividends at a moment’s notice, so this strategy may not suit all investors. Other passive income strategies may be more predictable.
However, I am comfortable with this approach, which is why I would buy all of the above shares for income today.
Rupert Hargreaves owns shares of British American Tobacco. The Motley Fool UK has recommended British American Tobacco, Dominos Pizza, Imperial Brands, and Moneysupermarket.com. 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.