Investors can make £5,000 a year in passive income with these stocks!

Passive income is the holy grail of investing for many investors. And it can be done by investing in stocks that pay shareholders dividends on a regular basis.

So, let’s take a closer look at how you can make £5,000 a year with passive income.

Produce sustainable

The highest sustainable yield in FTSE 100 it is around 8%. That’s my opinion. But these stocks don’t offer much in the way of share price growth. The majority of the total returns will come in the form of dividends.

We want to invest in companies that produce sustainable returns. Over the past few months, we’ve seen what happens when companies can’t pay their predetermined dividends – take a look Direct Line Group.

One way to determine if a company has a sustainable dividend yield is by looking at the dividend coverage ratio (DCR). It shows how many times a company can pay dividends from its earnings in a year. Usually, a DCR of two and above is considered healthy.

But it is worth remembering that some stocks can have strong and stable capital generation, but lower DCR. The dividend may be as strong as that of a cyclical stock that has a DCR above two.

8% yield

Following the recent stock market correction, we have seen dividend yields in certain sectors rise. This is because dividend yields and stock prices are inversely related.

The sector that suffered the most damage was financial stocks. Some stocks in this sector have offered attractive deals, but downward pressure on share prices sent the results up.

Among my favorites are Legal & General, Phoenix Group, Avivaand Close Sibling Group. The stock offers 8%, 9.2%, 7.5%, and 7.7%. DCRs, combined with cash generation data, suggest relatively safe dividends – of course, nothing is guaranteed when investing.

So, by investing in these four stocks, I can average an 8% dividend yield. But to earn £5,000 a year in passive income, I would need £62,000 in capital.

Compound returns

Some investors don’t have £62,000 of capital, but we can make it work by using a compound return strategy. Compound return is a powerful investment concept that includes both the return on the original investment and the return earned previously.

In essence, I invest the dividends every year and earn interest on my interest. And the longer I leave it, the more money I will have due to exponential growth.

So how can you earn £62,000 by investing in shares with an 8% return? Well, if I start with £12,000, it will take me 20 years of investing and reinvesting in 8% stock yield to have £60,000. If I start with £30,000, it will take me nine years, and if I start with £40,000, it will take me only five years.

When I hit the £60,000 figure, I can start using £5,000 a year in passive income to help finance my life.