How I’d invest £20,000 in stocks to target £1,000 in annual passive income

Building passive income streams is one of my top priorities for 2023. My preferred way to do this is investing in dividend stocks. I’m pleased to say there are plenty of FTSE 100 and FTSE 250 income-generating shares that look like good buys for me at present.

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With a £20,000 lump sum to invest, I’d target a 5% dividend yield from my stock market portfolio. This would mean I’d earn £1,000 each year on top of my salary — and that could be just the beginning of my journey towards a reliable second income.

Here’s how I’d aim for my target in three simple steps.

1. Stocks and Shares ISA

First, I need to decide what investment vehicle I should use to build my passive income portfolio. With a £20k annual contribution allowance each year, I’d choose a Stocks and Shares ISA.

The main advantage of an ISA is the favourable tax treatment of capital gains and dividends. Provided I keep my investments sheltered in the wrapper, I can maximise my stock market returns by avoiding taxes that are typically levied on investments.

Of course, there’s a risk the rules might change in the future. Nonetheless, I can only work with the tax regime as it stands. In that context, an ISA is a great choice as the vehicle to use for my investments. I can withdraw from it at any point, unlike a pension, which can usually only be accessed in later life.

2. Dividend stocks

Second, I need to identify good investment opportunities from the ranks of dividend shares that can produce regular passive income. Several FTSE 350 stocks offer sufficiently high yields to meet my 5% target.

For instance, I could buy shares in FTSE 100 housebuilder Taylor Wimpey, which yields 7.4%. But I wouldn’t concentrate all my £20k investment into one stock, as there are significant benefits to diversification. By spreading my risk across companies and sectors, I’m boosting my chances of securing reliable passive income streams from my dividend stocks.

Sticking with the UK’s blue-chip benchmark, I could also buy shares in commodity trading and mining business Glencore, which yields 9.6%. In addition, I could invest in the FTSE 250’s price comparison website operator, which yields 5.11%.

There’s always a risk that dividends can be cut or suspended — and this applies to all the companies I’ve mentioned above. Nonetheless, with a carefully selected basket of high-yielding stocks from different industries, I hope I could deliver my 5% target.

Indeed, if these firms outperform, I might secure a higher yield on my portfolio. That would mean I’d earn even more than £1k per year in passive income from a £20k lump sum.

3. Long-term passive income streams

Third, if all goes to plan, after a year of holding my equity positions I’d have £1,000 in passive income to my name. Fantastic! So, it’s time to sell right?

Not so fast.

There are huge benefits to long-term investing. Perhaps the most compelling is the miracle of compound returns.

If I reinvested my dividends and continued to allocate spare cash into the stock market, I could be well on my way to building a passive income empire with a five-figure dividend yield.

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.

The post How I’d invest £20,000 in stocks to target £1,000 in annual passive income appeared first on The Motley Fool UK.

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Charlie Carman has positions in Taylor Wimpey Plc. The Motley Fool UK has recommended 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.