Investing £5k of savings can generate a passive income of…

Buying dividend shares is a rapid and simple way to start earning a passive income. As with every investment, there are risks involved. But such threats can be managed through prudent decision-making and portfolio diversification. And when done well, the subsequent income stream can be quite lucrative, especially in the long run.

So let’s say an investor has £5,000 of capital sitting in a savings account. How much passive income can this money generate overnight and over the long term?

Crunching the numbers

The amount generated depends on which dividend stocks an investor decides to buy. Most tend to stick with simple index tracker funds. And right now, the FTSE 100 index offers a respectable 3.4% yield. That means, overnight, a £5,000 could generate a passive income of £170 a year. Obviously, that’s not a groundbreaking sum, especially since many savings accounts offer similar returns right now at much lower levels of risk.

However, there’s also capital gains to take into consideration. And when combined with the dividend yield, the FTSE 100’s historically generated close to an 8% annualised return for investors. Let’s assume this trend continues over the next decade. What does this mean for an investor’s passive income if they decide to reinvest any dividends between now and 2035?

Without any additional capital, the original £5,000 will have grown to around £11,100. And if the yield’s still 3.4%, that means the passive income stream will reach £377.40.

That’s a notable improvement. But what if we can do even better?

Boosting income with stock picking

Instead of relying on an index fund, investors can take matters into their own hands and invest in individual stocks directly. And right now, there are plenty of FTSE 100 constituents offering significantly higher yields. Take Aviva (LSE:AV.) as an example to consider.

Today, the insurance giant already offers a more impressive payout with a 5.9% yield. So a £5,000 investment would instantly unlock an annual passive income of £295. But those who hopped on the bandwagon just five years ago are already earning considerably more.

Following the appointment of CEO Dame Amanda Blanc in 2020, the company has undergone a significant transformation. It divested its non-core business ventures, raising over £8bn while simultaneously streamlining operations.

Pairing this increase in efficiency with boosted activity within the annuity market, courtesy of higher interest rates, shareholders have been immensely rewarded. The Aviva share price has more than doubled, turning a £5,000 investment into £10,400. And at the same time, dividends were hiked by an average of 18% a year, turning an already substantial 5.3% yield at the time into a 12.2% payout. As such, a £5,000 initial investment in 2019 is now generating a passive income of £1,268.80.

Sadly, Aviva shares aren’t guaranteed to replicate this success between now and 2030. The company’s still attempting to digest its £3.7bn acquisition of Direct Line Group. And with the UK government flirting with new mandates to force pension funds to invest more in UK assets, compliance-related costs of evolving regulation could create new headaches that impede performance.

Nevertheless, Aviva serves as a good example of how stock picking opens the door to potentially superior returns in the long run.

The post Investing £5k of savings can generate a passive income of… appeared first on The Motley Fool UK.

But here’s another bargain investment that looks absurdly dirt-cheap:

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

More reading

Zaven Boyrazian has no position in any of the shares mentioned. 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.