I firmly believe that investing in stocks and shares is one of the best ways to generate a passive income for life.
As such, if I had a lump sum of £100,000 today, I would acquire a portfolio of equities.
Passive income stars
I am looking for stocks that have a good track record of returning cash to investors.
There are lots of businesses listed on the London market with high dividend yields. That does not necessarily mean these are the sort of companies I want to acquire for my portfolio.
I would rather buy stocks with lower yields, but with higher levels of dividend cover. The latter means that a company’s dividend is well covered by earnings generated from operations. If the payout is not covered by generated earnings, the group is distributing more to shareholders than it can realistically afford.
With that in mind, I would acquire consumer goods giants Unilever and Reckitt.
Both of these companies are only paying out a relatively small amount of their earnings to shareholders in dividends, which suggests the payouts are sustainable.
I would also look for corporations that tend to distribute earnings in special dividends as well as regular payouts. Special dividends provide more flexibility to increase the payout in the good times and reduce it when profits fall.
One of the companies that has a long track record of introducing special dividends when profits rise is Admiral. I already own this stock. I would buy more if I had to invest a lump sum of £100,000 for a passive income stream today.
As well as individual companies, I would also buy investment trusts. These do not have to pay out all the income they receive on their investments every year. They can hold back a percentage of revenue and use this to cover dividends if income drops.
On that basis, I think they are the perfect income investments. A company with one of the best track records is in this space is City of London Investment Trust. This company has paid and increased its dividend every year for more than five decades.
Due to the size and diversification of this investment trust, I could invest in a large lump sum in the business. An investment of £50,000 would not seem unrealistic.
As the trust’s underlying portfolio is well-diversified, I will not be putting all of my eggs in one basket.
The downside of using this approach is that trusts usually charge management fees. These can have an impact on returns in the long run. There is also no guarantee the trust will be able to maintain its dividend.
And that is the case with all of the companies in this article. A sudden increase in costs or economic disruption could force any of these businesses to rethink their payout plans.
Despite these challenges, I continue to believe equities are the best investments to generate passive income for the long term. That is why I would acquire the stocks and trust outlined above for my portfolio today to build an income stream for life.
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Rupert Hargreaves owns Admiral Group, Reckitt plc, and Unilever. The Motley Fool UK has recommended Admiral Group, Reckitt plc, and Unilever. 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.