Passive income’s often said to be the ‘holy grail’ of personal finance. With this form of income, investors get paid without having to actively work for the money.
Here, I’m going to explain how UK investors can potentially build up a ton of passive income within an ISA in just a few simple steps. Let’s get into it.
Pick the right ISA
Thanks to higher interest rates, it’s possible to generate passive income within a Cash ISA. At present, some of these accounts are offering interest rates of over 5%.
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However, if an investor wants to generate a really high-level income, Stocks and Shares ISAs are a better bet, in my view. That’s because these products offer access to high-yielding investments such as dividend stocks and income funds.
So if I was looking to create a powerful passive income stream, I’d start by opening this type of ISA.
Look for attractive dividend stocks
Once I have an account open, my next move would be to identify some attractive high-yielding dividend stocks.
Now, this part of the process can be a little tricky. This is due to the fact that high-yielding stocks don’t always turn out to be good investments.
Sometimes, a high yield’s actually a signal that the underlying company has fundamental problems. So it’s important to look beyond a company’s yield and think about its long-term prospects.
One dividend stock I like the look of today is FTSE 250 company the Renewables Infrastructure Group (LSE: TRIG). It’s an investment company that owns a portfolio of clean energy assets (wind and solar farms etc).
Looking ahead, the transition away from fossil fuels towards renewable energy is likely to be a huge theme. So the backdrop for this company should be quite favourable.
Currently, the yield here is around 7.75%. This means that a £3k investment could potentially generate annual income of about £233 (dividends are never guaranteed though).
Over the last two years, this company’s share price has taken a hit due to higher interest rates. After this fall, I reckon now’s a good time to consider building a position in it.
That said, there’s always the chance that the share price could dip further. Falling energy prices are one risk to consider with this company.
Diversify to reduce risk
Given that every company has its own risks, the last step in my passive income plan is spreading capital out over a number of different stocks.
This move – which is known as ‘diversifying’ a portfolio – can help to reduce stock-specific risk. This, in turn, can improve the chances of generating strong overall returns.
For example, if you only own three stocks and one of them tanks, your overall returns could be ugly. However, if you own 20 stocks and one falls heavily, it’s probably not going to be so bad.
If you’re looking for more stock ideas to build a diversified passive income portfolio, you can find plenty here at The Motley Fool.
