How I’d invest £20,000 in UK shares to target £1,500 a year in passive income

UK stocks are offering some of the highest dividends anywhere in the world right now. These can provide a steady and growing source of passive income for investors.

Here, I’ll go through the steps I’d take to aim for £1,500 a year in dividends from a £20k investment.

Getting started

For the purposes of this article, I’ll assume I have a £20k lump sum to invest. This is the current annual allowance on a Stocks and Shares ISA. Investing through an ISA this way means any returns I make are shielded from capital gains and income tax.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Building a resilient portfolio

To aim for £1,500 a year in dividends from £20,000, I’d need to invest in a group of stocks that collectively yield 7.5%.

There’s no hard and fast rule on how many stocks a portfolio should have. It depends on one’s risk tolerance and experience. But I’d certainly want at least 10 stocks if I’m just starting out. That’s because no individual dividend is every guaranteed.

Take Tesco, for example. Britain’s largest grocery chain was once considered a core holding for UK dividend investors. It upped its payout for 27 years until 2012.

Then it ran into a number of financial difficulties and in 2014 cut its interim dividend by 75%. The following year it pulled the plug entirely and the payout didn’t return until late 2017 (at a far lower yield).

Clearly, this would have been disastrous for investors whose income portfolio wasn’t adequately diversified.

The lesson is that it pays (quite literally) to have a nice spread of high-quality dividend stocks to offset the risk of cancellations and reductions.

Too cheap to ignore any longer

So what would qualify as a high-quality income stock in my book?

Well, one that I recently bought was HSBC Holdings (LSE: HSBA). At 637p, the stock is currently trading at a ridiculously cheap 5.8 times earnings and below its book value.

For 2023, City analysts expect the bank to dish out a total dividend of $0.63 per share (50p at current exchange rates). That puts the dividend yield at a mighty 8%.

There’s also a special dividend expected this year after the company offloaded its Canadian business for $10.2bn. That would put this year’s yield at just over 10%!

Now, given the firm’s name — The Hongkong and Shanghai Banking Corporation (HSBC) — it’s no surprise to learn that 55% of its revenue is generated in Asia. Therefore, the ongoing property crisis in China might partly explain why the stock is so cheap.

Investors seem concerned about how much exposure HSBC might have here, as well as the knock-on effects for the wider region. The firm has already set aside $500m for expected loan losses associated with commercial property in China.

However, as a truly global bank, HSBC also generates plenty of profit from the rest of the world. And despite the current issues in China, I have to think Asia is a great place to be operating in long term. It is still the world’s fastest-growing region.

Seizing opportunities

Bagging an 8% yield like this would go a long way to helping me reach my 7.5% yield for £1,500 in annual dividends.

Looking forward, however, I highly doubt investors will always be able to bag these types of high dividends. Eventually, the dark clouds will part and sunnier economic times will shine through.

By then, of course, it’ll probably be too late. Markets will rise and quality stocks like HSBC won’t be offering such lip-smacking passive income. So I’ve been striking while the iron is hot.