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How to generate £5,000 a year in passive income!

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Image source: Getty Images

Passive income is the holy grail for many investors. Myself included. But, naturally, you need to have money to generate passive income. So how could I generate £5,000 a year in passive income when starting with nothing?

Let’s take a look.

Compound returns

The strategy I use is compound returns. Compounding is a powerful concept and it involves investing in dividend stocks and earning interest on my interest, as well as from the original investment.

Essentially, the compound returns strategy is very much like a snowball effect. And the longer I leave it rolling on, the more money I’ll have in the end.

So if I want to generate £5,000 a year in passive income, I need to have £100,000 invested in stocks paying 5% dividend yields, on average.

If I’m starting with nothing, I can actually generate a £100,000 portfolio quicker than many would anticipate.

If I were to invest £450 a month, or £5,400 a year, in dividend stocks, and achieved 8% total returns — broadly in line with the index average — after 10 years of using a compounds returns strategy, and increasing my contribution by 5% a year, I’d have £100,294!

That’s great, because if I put my money in stocks paying 5% yields, I can earn £5,000 a year in passive income.

It’s also worth noting that if I practice this compound returns strategy for longer, I’ll get more back. After 30 years, I’d have £1.1m. The growth is exponential. I also have to note, of course, that none of this is guaranteed and I could lose money too.

Where to put my money?

The above strategy is a good start, but the hard part comes when we need to pick stocks. I’m looking for dividend stocks, paying sizeable, yet sustainable, yields.

So I’m starting with Lloyds. It’s my top long-term pick and it’s a boring one, I know. The stock offers a 4.6% dividend yield at the moment, but the forward yield is for 5.4%, moving upwards to 6.25% for 2024, according to analysts’ estimates.

Some investors won’t like the bank’s UK focus. But, right now, that’s not proving to be a bad thing. Net interest income is surging and the current forecast looks like a moderate 2-3.5% base rate for 2024-2026. To me, that looks positive for interest income and impairment charges.

Another stock, which I’ve recently topped up on, is Legal & General. The British multinational financial services and asset management company offers a sizeable 7.5% dividend yield, and has delivered slow but steady share price growth over the long run. It’s something of a cyclical stock and can suffer when economies go into reverse. But, for me, it’s fairly solid.

Finally, I’m looking a Greencoat UK Wind. I’ve recently bought this stock with the wind-focused trust benefitting from higher energy prices. It currently offers a 4.7% dividend yield, but this will rise in line with retail price index inflation, taking the forward yield to around 5.3%. Wind can be temperamental, but I only see the industry becoming more attractive with technological developments. Share price gains have been steady.

The post How to generate £5,000 a year in passive income! appeared first on The Motley Fool UK.

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James Fox has positions in Greencoat Uk Wind Plc, Legal & General Group Plc, and Lloyds Banking Group Plc. The Motley Fool UK has recommended Greencoat Uk Wind Plc and 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