These FTSE 100 stocks could turn a £10k starting investment into a £5k annual income

The FTSE 100 is great place to find high-yielding dividend stocks. And for me, that’s great. My portfolio is built around these stocks, allowing me to practice a compound returns strategy. Of course, I also have the options to use these dividends as passive income.

But it can be hard to get started. So here’s how we can go about flipping a £10k investment into a cash-generating asset.

What we know

As noted, the UK blue-chip index is a great place to find dividend stocks. In fact, some 90% of stocks on the bourse currently pay a dividend, and the average yield is around 3.65%. But we can do much better than that.

There’s a host of companies and sectors, such as high-yielding insurance stocks, that are known for their sizeable dividends.

When investing purely for dividends, I believe the highest sustainable yield achievable is around 8%. It’s worth remembering that some of these stocks, such as Legal & General, offer big yields, but very little in the way of share price growth.

If possible, I’ll also want to use an ISA wrapper as dividends earned from this portfolio will be exempt from taxation.

The process

So we’re starting with a lump sum of £10,000. And we’re attempting to turn that into an annual dividend of £5,000. Naturally, there aren’t any companies offering 50% dividend yields — and even if there were, it would definitely be a warning sign.

To generate £5,000 from stocks averaging an 8% yield, we need to have £40,000 invested. So how can we turn £10,000 into £40,000? My answer is investing frequently over time and reinvesting my dividends year after year until I hit that magic number — £40,000.

So if I invested my £10,000 in stocks paying 8%, then I contributed £200 a month — while increasing that contribution by 5% a year — and reinvested dividends annually, after 6.5 years I’d have £40,000. That’s a very short period of time over which to quadruple my holdings!

The stocks

So how can I do this using FTSE 100 stocks? Well, I need to find stocks with the required yield but with sustainable dividends.

I also need to ask whether these yields are truly sustainable. And a great place to start is the dividend coverage ratio — this shows how many times a company can pay its stated dividends from earnings.

A ratio above two is broadly considered healthy, but I’m also on the lookout for firms with strong cash flows.

So which companies could help me do it? Well, here are some of the biggest yielding stocks on the index.

My top picks from this list are Phoenix Group, Legal & General, and Vistry Group. Of course, dividends are by no means guaranteed, but I believe the ones offered by these stocks can be maintained.

I may be tempted by M&G however, the company’s dividend coverage ratio turned negative last year as M&G registered a loss. After which, the investment manager actually increased the yield. The forward coverage ratio may be much stronger.