A passive income is an earning stream that doesn’t have to be worked for. There are many ways to create a passive income. From buy-to-let property to book royalties, passive income streams aren’t the exclusive right of the wealthy. I believe one of the best assets to buy for a passive income is UK shares.
Indeed, unlike other assets, investing in shares is relatively straightforward. What’s more, it doesn’t require a massive amount of initial capital, like buy-to-let investing. This strategy might not be suitable for everyone. After all, profits are never guaranteed in the stock market.
Nonetheless, with an investment of just a few thousand pounds it’s possible to generate an income stream from the market. Although it may not be a revolutionary amount of money, it will still qualify as a passive income.
That’s why I’ve a portfolio of UK shares designed with a single goal in mind. Generating a passive income.
Passive income portfolio
There are two strategies investors can use to generate a passive income from stocks and shares. Either buying stocks directly, or acquiring funds. Both approaches have their benefits and drawbacks.
For example, buying funds can be a straightforward way to build a passive income portfolio quickly. However, many fund managers lag the market in the long term. What’s more, there’s always going to be a chance that a manager ends up causing investors losses. This is rare. But the Neil Woodford saga showed it could happen.
Investment trusts are similar to equity investment funds. But, as they’re managed as companies, they’re also allowed to hold back a percentage of revenue every year to cover dividends in times of uncertainty. This proved to be incredibly useful last year.
As UK shares across the markets slashed their dividends, many investment trusts maintained their dividend commitments by dipping into dividend reserves. This quality will not eliminate the risk of a dividend cut altogether, but it could minimise it. Two of my favourite dividend trusts, which I currently own, are Murray Income and Scottish Investment.
UK shares for income
The other investment strategy is to buy shares directly. This process can be a bit more challenging. Selecting individual dividend stocks isn’t easy. Last year, many companies that had been considered dividend champions for decades were forced to cut their payouts. That was a potent reminder to investors that nothing is ever guaranteed when investing.
Still, I’m comfortable with this potential risk. One of the companies I own in my passive income portfolio is British American Tobacco. This company has one of the highest dividend yields on the market. It currently stands at 8%. This reflects the fact the company operates in the tobacco sector, which is seeing declining revenues. As such, the distribution is by no means guaranteed in the long term.
The bottom line
A portfolio of £5,000, comprised of the three investments outlined above, could yield 5.3%. That could give me a potential annual passive income of £263. It’s not much, but it is a start. Over time, thanks to the power of compounding, this figure should continue to grow as I reinvest my dividends.
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Rupert Hargreaves owns shares in the Murray Income Trust, Scottish Investment Trust and British American Tobacco. The Motley Fool UK has no position in any of the shares mentioned. 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.