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

Dr James Fox explains how he’d generate plenty of passive income annually by investing regularly and choosing sustainable dividend stocks.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Smiling black woman showing e-ticket on smartphone to white male attendant at airport

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

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.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

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.

Investing in AI: 3 Stocks with Huge Potential!

🤖 Are you fascinated by the potential of AI? 🤖

Imagine investing in cutting-edge technology just once, then watching as it evolves and grows, transforming industries and potentially even yielding substantial returns.

If the idea of being part of the AI revolution excites you, along with the prospect of significant potential gains on your initial investment…

Then you won’t want to miss this special report inside Motley Fool Share Advisor – 'AI Front Runners: 3 Surprising Stocks Riding The AI Wave’!

And today, we’re giving you exclusive access to ONE of these top AI stock picks, absolutely free!

Get your free AI stock pick

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

More on Investing Articles

Investing Articles

Up 20% in a month, should investors consider buying Marks & Spencer shares?

Shares in retailer Marks and Spencer have surged ahead over the last month, despite a cyberattack. Roland Head takes a…

Read more »

Charticle

Here are the latest growth and share price targets for Nvidia stock

Ben McPoland checks out the latest forecasts for Nvidia stock to assess whether it might be worth considering for a…

Read more »

Growth Shares

Yikes! This could be the most undervalued growth stock in the FTSE 100

Jon Smith flags up a growth stock with a low price-to-earnings ratio and a share price back at 2020 levels…

Read more »

Abstract bull climbing indicators on stock chart
Investing Articles

3 beaten-down FTSE 250 shares to consider buying before the next bull market

Paul Summers thinks brave investors should ponder buying some of the FTSE 250s poor performers before they recover strongly.

Read more »

Investing Articles

Gold prices soar while the Fresnillo share price slumps. What gives?

With a gold bull market in full swing, this Fool argues that the falling Fresnillo share price may not remain…

Read more »

Investing Articles

2 FTSE 100 shares I’m avoiding like the plague right now

While the FTSE remains packed with opportunity, many of the index's blue-chip shares could be at risk as trade tariffs…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

Here’s how an investor could aim for a million buying under 10 shares

Christopher Ruane explains why doing less, not more, of the right things could be the key to success as an…

Read more »

Investing Articles

Could this new risk cause a stock market crash?

Tariffs and a potential recession are two major stock market risks right now. But there’s another risk that concerns Edward…

Read more »