How to aim for £1,500 a year from £20k of FTSE 100 stocks!

The FTSE 100 is a great place to look for dividend stocks. The index hosts tens of established companies, many of which I believe to be undervalued, that pay sizeable dividend yields.

These stocks are perfect if I want to turn a lump sum like £20,000 — equivalent to the maximum ISA allowance — into a regular income. For me, I believe £1,500 is around the maximum I can achieve by investing in FTSE 100 stocks.

So let’s take a look at why that is and how I’d go about earning £1,500 in passive income.

FTSE 100 dividend stocks

I tend to invest in UK-listed stocks and the FTSE 100. The index hosts many unloved but established companies that reward their shareholders with strong, yet not guaranteed, dividends.

It’s worth noting that British stocks tend to trade at discounts versus their American counterparts. In fact the average price-to-earnings in on the FTSE 100 is around 13, while on the S&P 500 it’s closer to 19.

Yes, there are more growth stocks on the US market, and they naturally trade at greater multiples. But it’s also the case that UK stocks just aren’t as attractive to a wider international audience.

But that’s good for dividend yields. Because when share prices go down, dividend yields go up. So if I’m investing in a depressed market, I can expect to find better yields.

There are several sectors that have pushed down in recent months, including financials. There has been something of a recovery here, but not a full one. With share prices falling there’s certainly opportunity to pick up some big yields.

It’s also important to remember that the yield at the time of purchase will always be relevant to me, regardless of share price movements.

My picks

So if I’m trying to turn £20,000 into £1,500 a year, I need to invest in stocks paying 7.5% dividend yields. For me, 7.5% is around the maximum I believe I can achieve without sacrificing the sustainability of the yield.

Sustainability is key. Naturally, we don’t want to invest in a company to find out that its management have decided to cut the yield because it’s no longer affordable. One way to do this is by looking at the dividend coverage ratio.

A DCR around two can be considered healthy, but a company with a lower DCR and strong cash generation can have a sustainable yield too. Obviously, nothing can be guaranteed. And there’s always a risk the dividend will be cut.

But if I do my research, I should be able to minimise this risk.

Moreover, I’m not one to spread by investments too thinly. That’s because I’d rather invest in a handful of companies that I know well rather than a host of companies I can’t accurately research.

Collectively, by investing in these stocks, I could achieve an average return — in the form of dividends alone — around 7.5%. With shares in all of these companies, I’m hoping to achieve total returns around 10% for the year.