How I’d build a passive income portfolio with £10k

Building a substantial passive income stream is a financial goal that many Britons share right now. It’s not hard to see why – with extra cash rolling in on a consistent basis, investors have far more financial freedom and flexibility.

The good news is that you don’t need a lot of money to start working towards this goal. With that in mind, here’s how I’d build a passive income portfolio with £10k today.

The right investment vehicle

If I had £10k in cash and I was looking to create a long-term income stream, the first thing I’d do is open a Stocks and Shares ISA. This would be the investment vehicle for my passive income portfolio.

Why would I use this type of account? Three reasons. First, all my income would be completely tax-free (a huge benefit). Second, I could buy high-yielding investments such as dividend stocks in it. Third, I could access my money at any time.

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.

Multiple approaches

Next, I’d look to build a portfolio of high-yield investments. And there are several approaches I could take here.

I could invest in a fund that aims to generate income. An example here’s the Vanguard FTSE UK Equity Income Index. It offers a yield of about 5% right now. In other words, if I invested my £10k in this product, I‘d pick up around £500 in income a year.

Alternatively, I could invest in income-focused investment trusts. These are like funds but they trade on the stock market. One example here is the Merchants Trust. It also offers a yield of about 5% today.

But what I think I’d do is select a bunch of high-yielding dividend stocks (these stocks pay cash to shareholders on a regular basis out of company profits). This could potentially give me a higher yield.

I’d probably go with eight different stocks (£1,250 in each, ignoring trading commission). This would help to diversify my portfolio and reduce my risk levels.

A great stock for income

Now, I wouldn’t necessarily go for the highest yielders in the market. Sometimes, companies with high yields have fundamental problems. And these problems can lead to share price weakness. This can offset any gains from income.

What I’d do is look for companies that have both healthy yields and attractive long-term prospects. I’d also look for companies with decent dividend coverage ratios (this is the ratio of earnings to dividends and it provides clues as to how sustainable a company’s dividend is).

One company that fits the bill here is HSBC (LSE: HSBA). Its yield is definitely appealing. Last year, the bank paid out 61 cents per share in dividends to investors. That translates to a yield of about 7% today.

Meanwhile, the dividend coverage ratio’s solid. Last year, it was about 1.9, which indicates that earnings comfortably covered the dividend payout.

Additionally, the company has attractive long-term prospects. In the years ahead, HSBC plans to focus on high-growth areas of banking such as Asia and wealth management.

Of course, the banking industry can be volatile at times. So there’s a chance that returns from this particular stock could be disappointing in the short term (dividends are never guaranteed).

However, if I was to select eight stocks from different areas of the market, including a few more defensive plays, I reckon my passive income portfolio would generate decent returns for me over time.