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3 simple steps I’d take today to make a passive income with UK shares

Peter Stephens
·3-min read

Investing money in UK shares could produce a relatively high passive income over the long run. Certainly, there is an ongoing threat of a second stock market crash. However, the high yields and long-term growth potential offered by FTSE 100 and FTSE 250 shares could mean that they produce an impressive income return compared to other mainstream assets.

By opening a tax-efficient account such as an ISA, buying financially-sound dividend shares and diversifying across a wide range of businesses, an investor could maximise their income from UK shares.

Opening a Stocks and Shares ISA

A Stocks and Shares ISA offers a simple and cost-effective means of making a passive income from UK shares. An ISA can be opened online in a matter of minutes. Doing so is often without any initial cost in many cases, while annual management fees are similar to the cost of a single trade. Therefore, they are accessible to smaller investors.

An ISA provides income investors with significant flexibility. Withdrawals can be made at any time without penalty. This means that, unlike with a SIPP, capital invested in an ISA can be used in case of emergency. This may make them particularly attractive to individuals who may need access to their funds at some point prior to retirement.

ISAs also offer a tax-efficient means of generating a passive income. This may not sound relevant to some investors who may not yet pay tax on dividends or capital gains. However, over a lifetime, capital gains and dividends can add up. Therefore, ensuring that any investment is not subject to tax could lead to a larger portfolio and a more generous passive income.

Buying UK shares to make a passive income

It is tempting to simply purchase the highest-yielding UK shares to make a passive income. However, this may not be an effective means of generating a sustainable long-term income. For example, high dividend yields may be unaffordable – especially in the current economic climate. Therefore, investing money in financially sound businesses with lower and more reliable yields could be a more prudent approach.

Assessing a company’s financial strength can be done through analysing its balance sheet. Low debt levels signal a solid financial position. Meanwhile, an affordable dividend, assessed through a company’s dividend cover, may suggest that its shareholder payouts are affordable and unlikely to be cut.

Diversifying among UK shares

Of course, buying UK shares for a passive income is a relatively risky strategy. Other assets such as cash and bonds offer less risk of loss.

However, an investor can reduce their overall risk through buying a diverse range of companies. This cuts their dependency on a small number of companies and sectors so that they can enjoy a more resilient and robust income that has a higher chance of growing over the long run.

The post 3 simple steps I’d take today to make a passive income with UK shares appeared first on The Motley Fool UK.

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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.

Motley Fool UK 2020