There’s definitely nothing wrong with having some cash set aside for a rainy day (or sudden emergency). But the last couple of years have taught us that this can lose value over time, due to the eroding power of inflation.
With interest rates on savings accounts likely to continue falling in 2025, I think investors can aim to generate far more passive income via the stock market.
First steps
Getting started requires opening an investment account. One option is a Stocks and Shares ISA. This allows UK investors to put up to £20,000 to work in the stock market every year. They also won’t pay tax on any profits or income (in the form of dividends) they receive.
Now, I don’t know many people who are able to put the maximum amount in every year. In fact, I’m not sure I know many people who are able to do it just once! But even a few quid will allow novice investors to get a feel for how markets work (and the risks involved). And those blessed with many years of investing in front of them can always increase their contributions as the years pass.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Monster yield!
One example of a company that investors may then wish to contemplate buying a stake in is insurance giant Aviva (LSE: AV).
Based on the current price, the shares are down to yield a huge 8.1% in FY25. This would easily make it one of the biggest payers in the FTSE 100 index. By comparison, the index itself yields around 3.7%. So shareholders would be getting a lot of passive income bang for their bucks.
Now, let’s say an investor put the full annual £20,000 ISA allowance into Aviva. All things staying the same, this would produce £1,620 in passive income a year (or £135 a month).
Rather than spending that money, an investor could choose to reinvest it. Compounding that yield alone over 20 years would result in a pot of just over £100,000. This would then give £678 a month in dividends.
But this is only based on the share price going nowhere and no extra cash being added. I reckon the former could be a lot higher, especially if current CEO Amanda Blanc continues to streamline the £12bn-cap business during her tenure. The recent capture of motor insurance peer Direct Line could work out well too.
Safety in numbers
As high as Aviva’s dividend yield is, I certainly don’t think it’s the only stock that’s worthy of attention. And nor should it be. The last thing an investor would want is for those dividends to be cut. And yet that’s exactly what can happen if a company encounters problems.
This has happened quite a few times before in Aviva’s history, usually during tricky economic times. Think the Great Financial Crisis and the Covid-19 pandemic.
For this reason, spreading that £20,000 around, say, 10 or so big income stocks feels prudent. If one or two are then forced to reduce the amount of money they send out to shareholders for a while, the remainder should compensate. An investor might receive a smaller amount of cash but it’s unlikely (but not impossible) that they wouldn’t receive any at all.
The post Here’s how an investor might aim to turn £20,000 into £678 a month of tax-free passive income appeared first on The Motley Fool UK.
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More reading
Are Aviva shares the biggest no-brainer ISA buy for 2025?
Never fear! Getting started with passive income is easier than many people think
3 reasons to start a Stocks and Shares ISA in 2025, and they’re not all good ones!
Best British value stocks to consider buying in 2025
Does acquiring Direct Line make Aviva shares a buy?
Paul Summers 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.
