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Forget buy-to-let: these are the stocks to buy for passive income!

Mature couple in a discussion while eating a meal in a restaurant.
Image source: Getty Images

I’m always on the lookout for stocks to buy that can enhance my portfolio’s passive income generation. But it can be hard to find the right stocks. After all, I’ve got to be wary of big dividend yields.

So, here are my top dividend stocks that I’d buy rather than entering the letting market.

Why I pick stocks

Buy-to-let certainly has some advantages, hence why so many Britons go down that route in an effort to generate more income. The trend in house prices has generally been upwards in recent years and yields can reach high single digits.

However, having experienced the buy-to-let market, where I received a 5% yield — about average in the south-west of England — I’m more inclined to invest in stocks going forwards.

Stocks offer me more flexibility. The FTSE 100 has achieved annualised total returns around 8% over the past two decades. That’s probably in line with a good buy-to-let investment, but I believe I can outperform the index by making wise decisions.

Of course, there are risks. Dividends are by no means guaranteed, and compared to housing, stocks can be more vulnerable to external shocks. But, that’s why I’ve got to do my research and invest wisely.

Finally, I’d add that buy-to-let investors could be lumbered with sizeable mortgages right now. Owners can’t immediately pass those costs on to renters. And if the rent exceeds what people are willing to pay, owners could be left with expensive voids.

Investing for passive income

For many, passive income is the holy grail of investing. So, if I’m investing for a second income, I’m looking for stocks with higher-than-average dividend yields, strong coverage ratios, and solid records of paying dividends.

I’d start with Lloyds. The bank is among my top picks on the index, offering a forward yield around 5.2% and solid dividend coverage. Lloyds recently announced that its profits remain flat as higher net interest income cancelled out higher impairment costs.

However, while bad debt remains an issue in the short run, the economic forecast is improving and higher interest income looks like a tailwind that will last longer than many expected. That’s why I’ve recently topped up.

I’ve also recently bought NextEnergy Solar, and this would be my next pick. The stock offers an attractive 6.2% yield while operating in a very excited part of the market — one with consistent technological advances.

As a real estate investment trust, the fund must distribute at least 90% of its taxable income to shareholders annually in the form of dividends. This often means the firm has to leverage debt to invest in new projects, which some investors don’t like.

Finally, I like Sociedad Quimica y Minera de Chile. The Chilean miner produces some of the cheapest lithium in the world. It has a 25% share of the global lithium market with 20+ years of reserves. After a slight dip in the share price, it now offers a 9% dividend yield. In fact, it’s one of the few US-listed stocks I own.

There were concerns that lithium prices could dip on falling Chinese demand, but growth in China looks strong this year, and I remain bullish on SQM.

The post Forget buy-to-let: these are the stocks to buy for passive income! appeared first on The Motley Fool UK.

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James Fox has positions in Lloyds Banking Group Plc, NextEnergy Solar Fund, and Sociedad Química Y Minera De Chile. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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 2023