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Generating passive income is a goal shared by many British investors. From retirees to younger investors, many people are looking to generate some cash flow from their investments.
While I'm not personally looking for income yet (I'm in the growth phase of investing), I often think about how I would build a sure passive income stream if you were looking for cash flow, which is what many investors are looking for. With that in mind, here's a look at how I think you should invest £20,000 to earn an income in 2025.
Directly to an ISA
My first suggestion would be to put that money into a stocks and Shares ISA. The reason you would do this is that any income generated within the account would be tax free.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
distributing my money
Next, I think investors should try to spread their money across a variety of different dividend stocks. These offer shareholders regular cash payments out of the company's profits.
Assuming they don't already own any income shares, they should probably try to invest the £20,000 in between 10 and 15 different shares. If they had that many stocks and a couple were underperforming, they would probably still do well.
Focusing on company fundamentals
As for how to choose stocks, I would look for a few things.
Firstly, I would suggest looking for companies with long-term growth potential. One thing I have learned is that if you invest in a company with poor prospects, you often end up in tears, even if the dividend yield is initially attractive.
Next, focus on companies with high dividend coverage ratios. This ratio measures a company's earnings per share versus its dividends per share and can indicate how secure a company's dividend payout is.
Generally speaking, a ratio greater than two is excellent, while a ratio greater than 1.5 is acceptable. If a ratio is close to or below one, it is a red flag.
I would also suggest looking for companies with strong balance sheets. If a company is loaded with debt, this can lead to a dividend cut because interest payments always take priority over dividend payments.
Lastly, I would generally avoid stocks with very high dividend yields (9%+). A high yield is often a warning sign that something is wrong and that a dividend is coming.
I would focus on stocks that offer returns between 4% and 7%. These returns tend to be safer than spectacularly high ones.
A high-income stock?
One stock that meets this criteria today is the pharmaceutical giant. GSK (LSE:GSK). As a drug and vaccine developer, I believe it has significant potential in a world where the population is growing and aging.
And the income on offer looks attractive: the yield is just under 5%.
Meanwhile, dividend coverage is healthy. By 2025, earnings per share are forecast to be 155p, easily covering the expected dividend payout of 60p (a dividend coverage ratio of 2.6).
As for the balance, it seems reasonable. It is true that it had net debt of £12.8bn as of September 30, but I think it is manageable.
Of course, this action has its risks. One to consider is the appointment of RFK Jr as US health secretary (he is a notorious vaccine skeptic).
Overall though, I think GSK has potential as a passive income play. For anyone looking for income, I think it's worth considering.
