I firmly believe that buying stocks and shares is one of the most straightforward ways of generating a passive income. Anyone can get started investing in equities from just a few £100, unlike other passive income strategies, which may require hundreds of thousands of pounds to get started.
It could also be possible to build a passive income portfolio with just £5,000. With that in mind, here’s how I’d invest £5,000 in my portfolio to generate a passive income.
Investing for passive income
I should start by saying that a portfolio of £5,000 won’t create a life-changing passive income stream. Based on current dividend yields available on the market, I could generate an income stream of as much as £400 a year.
Even by generating this modest level of passive income, I can improve my investing prospects. A return of £400 a year is equivalent to an annual yield of 8%.
If I were to reinvest this money back into the portfolio every year, it would be worth nearly £11,000 after a decade. Assuming everything else remained constant, this would be enough to generate an annual passive income of £880.
These numbers show how I can achieve a passive income by investing in stocks and shares. I should note that as dividend income is paid out profits, it’s never guaranteed. A sudden drop in profits could force a company to slash its dividend. This would be terrible news for passive income seekers.
As such, I’d only invest in what I believe to be high-quality income stocks. There are a handful of companies in the FTSE 100 I think meet this criterion.
The first I’d buy for my passive income portfolio is British American Tobacco. With a dividend yield of 8.3%, at the time of writing, the stock has one of the highest yields in the blue-chip index.
Alongside the cigarette producer, I’d also acquire pension management specialist Phoenix Group. With a dividend yield of 7.7%, at the time of writing, the stock once again meets all of my investing criteria for income shares.
Another financial stock I’d also buy for my portfolio is life insurance and pension manager Legal & General. With a dividend yield of 6.6%, at the time of writing, the stock looks extremely attractive as a passive income play.
Finally, I’d buy homebuilder Persimmon. With the housing market booming and profits rising, analysts reckon shares in the stock will offer a yield of 8.2% this year.
These four FTSE 100 stocks support an average dividend yield of around 7.7%. That suggests I can earn an income of £385 a year on my £5,000 investment.
I’d buy all of these companies, but they may not be suitable for all investors. Some investors might not be comfortable with the ethical considerations of owning a tobacco company. Others may not be comfortable owning financial services stocks, considering the industry’s poor track record.
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Rupert Hargreaves owns shares of British American Tobacco. The Motley Fool UK has recommended British American Tobacco. 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.