I can barely remember my first job (delivering pizza), not to mention the meagre wage I was on. What does come to mind is that my income hardly even covered my petrol costs… and that I didn’t stick around for too long. But 20 years on, and I’m generating more in passive income than my pizza delivery salary. The best part is, I don’t have to spend any of the income on petrol either. If I was to start again today, these are the investments I would make to generate £5,000 in passive income each year. Let’s take a look.
Passive income from the stock market
As far as generating passive income goes, I think the stock market is an excellent option. Options like buy-to-let properties and side hustles are valid too, but I don’t think they’re truly passive income streams.
This is where the stock market has a major benefit. If I buy shares of a company that’s generating a profit each year and paying a dividend, I get a small slice of the cash it was generating. So today, I buy dividend stocks to earn passive income. If my portfolio value was £100,000, then I’d need a 5% dividend yield to earn £5,000 in passive income each year.
Dividend stocks
My aim is to generate at least a 5% dividend yield, but also diversify my portfolio. Dividends are never guaranteed, and depend on the profitability of the companies. Therefore, if I was starting today, I’d spread my investments over different sectors.
I’d buy shares in Rio Tinto, the global mining company. The current dividend yield forecast is 9%, which is far higher than my target. Commodity prices can be volatile though, so my dividend stream would also likely fluctuate in value.
I’d also buy shares of housebuilder Persimmon. It has a mighty dividend yield of almost 10% for 2022. I’d need to keep in mind that the housing market could slow. Nevertheless, the dividend yield is big enough for me to compensate for this risk.
I think the financial services sector is also a great place to look for passive income. I’d buy companies such as Legal & General and M&G. Both have expected dividend yields of over 7% for this year. I’d be diversified across asset management and insurance businesses too. However, if the stock market crashed, then the assets that these companies manage would fall in value.
One final dividend stock I’d buy is British American Tobacco. Its dividend yield forecast is 7%, so above my 5% threshold again. The core tobacco business will likely be in structural decline from here, but the company is diversifying into non-combustible products.
Final thoughts
All of these companies offer dividend yields way above my 5% target. Therefore, I’d be generating more than an annual £5,000 passive income stream. But they come with risks too, of course, so that’s not guaranteed. But it’s comforting to think that if I could buy dividend stocks with at least a 7% dividend yield, I’d only need a portfolio value of £71,000 to generate my £5,000 passive income target.
It’s always a balance of risk and reward. But I think these companies will carry on paying dividends at these high yields, so I’d buy the shares in my portfolio to achieve my £5,000 annual passive income.
Dan Appleby owns shares of Rio Tinto, Legal & General and 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.
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