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

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Plenty of investors are looking to generate passive income in retirement, but making this work in practice needs active involvement.

I’m looking to fund my retirement by investing in the shares of individual FTSE 100 stocks, rather than slapping money into a tracker fund then sitting back. I reckon I can generate a higher level of income by actively building a diversified portfolio of shares rather than buying the entire index in one fell swoop.

Time to get active

This is a little riskier, but with luck my stock picking strategy should generate a higher return. That’s because I can target FTSE 100 companies that I think will go further towards fulfilling my investment goals. 

So instead of getting today’s average FTSE 100 yield of 3.53%, I could aim for 5% or 6%. This would make a big difference to my total return over time.

If I had £20,000 to invest in a Stocks and Shares ISA and was targeting an annual income of £1,000 in year one, I would need to generate a yield of 5%.

Plenty of FTSE 100 dividend stocks already pay more income than that. Mining giant Rio Tinto, for example, currently yields 9.71%. If I invested £20,000 into that one stock, I would instantly have income of £1,820 a year.

That would be risky, though. Dividend payments are not guaranteed. They can be cut at any time. While Rio’s looks safe right now, as it is covered 1.7 times by earnings, going all-in on one stock is far too risky for me.

I could balance that with a smaller, safer dividend, for example from pharmaceutical firm GSK. It currently yields 3%, which is below my 5% target, but the payout is covered 3.2 times by earnings, giving scope for progression. Next year, GSK is forecast to yield 3.8%. Even better.

Some great yields out there

Tobacco stocks pay some of the most solid dividends of all. For example, British American Tobacco‘s yield is 7%, covered 1.7 times by earnings, while Imperial Brands yields 6.98%, covered 1.9 times.

Tesco (4.43%), National Grid (4.98%), SSE (4.96%), BT Group (5.57%), and Aviva (6.55%) all pepper my 5% yield target, and would help me hit my passive income goal. Other stocks would help me thrash it, notably Barratt Developments (8.02%), Vodafone Group (8.16%), and M&G (9.14%).

I would have to do my due diligence to be sure these stocks will continue to generate the revenue streams required to make their dividends sustainable. Every company has its risks, as well as potential rewards, but the ones I have listed here look like promising picks for my Stocks and Shares ISA portfolio.

My 5% passive income target is only for the first year. My portfolio’s average yield is likely to grow over time, as companies raise their dividends and I reinvest them to buy more stock.

Retirement is still 15 years away. With luck, my £20,000 ISA investment should be worth a lot more by then, and give me a far higher passive income than £1,000 a year.

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

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Harvey Jones has positions in Rio Tinto Group. The Motley Fool UK has recommended British American Tobacco P.l.c., GSK, Imperial Brands Plc, Tesco Plc, and Vodafone Group Public. 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.