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Passive income is the goal for many investors. And this is achieved by investing in stocks paying a dividend to their shareholders. These dividends are by no means guaranteed, and can be cut when times get tough — the pandemic was reflective of this.
So today, I’m looking at how I could earn £1,500, or more, in passive income by investing £20,000 — equal to the maximum ISA contribution — in stocks and shares.
Why I’d invest now
The FTSE 100 might be pushing upwards again but, in truth, this isn’t reflective of the health of all British stocks. Surging resource stocks have hauled the index upwards.
The FTSE 250 is actually down 20% over the past year and this is more indicative of the current challenges. These challenges are largely down to the macroeconomic environment characterised by sky-high inflation, higher interest rates, and a likely recession.
But I’m confident the macroeconomic situation will improve, and the stock market with it. So why invest now?
Many stocks are cheaper than they were a year ago, but that’s not a reason to invest in itself. Many of them are cheap for good reason.
Instead, I’m looking for meaningfully undervalued stocks and healthy dividend yields. And these are normally easier to find when the market is depressed.
Dividend yields
The dividend yield is a financial ratio that tells me the percentage of a company’s share price it pays out in dividends each year. And when share prices go down, dividend yields — assuming the dividend payment remains constant — go up. This works in the other direction too.
So by buying top quality stocks when prices are down, I can lock in higher dividend yields and supercharge my passive income generation going forward.
Generating my passive income
If I were to invest £20,000 in stocks and shares now, I’d need an average 7.5% dividend yield across those investments to generate £1,500 this year.
I’d start with Direct Line Group, which currently offers a whopping 10% yield. The stock is up 15% since I bought it a month ago, but I’d still buy more. The firm was caught out by inflation but is now back to writing at target margins. It might not be an exciting part of the market but, for me, that’s what I want.
Next, I’d buy Close Brothers Group. The merchant bank is “well positioned” to successfully navigate the current “challenging period“, according to management, and RBC recently praised the firm’s defensive qualities. A recession isn’t good for credit quality but, with a solid base, I’d buy more of this stock for the 6% dividend yield.
My final pick is Phoenix Group. The insurer recently said it expects to deliver around £1.2bn of incremental, organic new business with long-term cash generation in 2022, despite the economic conditions. I added this stock to my portfolio in December for a healthy 8% yield.
