Building a passive income from stocks and shares need not cost the earth and the past performance of the market has been good.
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Investing £30 a week in stocks and shares has the potential to provide me with £6,000 a year of passive income. And I can draw that income for the rest of my life.
I’m sure this plan is possible because of the long-term performance of the stock market. For example, the FTSE 100 index started in 1984 at the level of 1,000. But by 2019 it had produced a 1,377% return with dividends reinvested along the way.
That huge gain works out at an average of 7.8% a year, although returns are never linear from the stock market. Shares are notorious for bouncing up and down a lot along the way.
But the American market has done even better for investors. The S&P 500 index produced an annualised average return of around 10.5% between 1957 and 2021 with dividends reinvested.
As a basis for my investment strategy, I’d start by putting my money in low-cost index tracker funds following shares in the UK and the US. A £30 a week investment works out at £130 a month and that’s how I’d play it.
Punching the numbers into an online compound interest calculator showed me what’s possible. I set the calculation to compound an annual return of 7% with regular investments of £130 each month.
The calculator told me I’d end up with a sum of money worth £152,946 after 30 years. But the interesting thing is I would have only invested a sum of £46,800 overall. The remaining £106,146 would come from the gains generated by that 7% annualised return — such is the awesome power of the process of compounding!
After 30 years I could stop contributing and switch to drawing the dividend income from my investments. Right now, the FTSE All Share index yields a dividend worth around 4%. And if I can get 4% on my £152, 946 in the future I’d end up with an annual passive income worth just over £6,000.
This illustration isn’t a guarantee. Nothing is certain when investing in stocks and shares and the figures are unlikely to work out exactly as those in this article. It’s even possible for my investments to disappoint in the future. Nevertheless, I’d go further and invest more each month as my income grows over the years. And that would give my future passive income a chance of keeping ahead of inflation.
On top of that, I’d also target higher annualised returns by investing in individual stocks and shares of quality businesses. Buying them alongside tracker investments could potentially be one of the most profitable strategies.
I’d aim to diversify across numerous sectors and hold at least 15 companies for around three to five years and often longer. Why? Well, it’s the ’80/20 rule’ in action. There’s a tendency for around 80% of the returns from a portfolio to be driven by just 20% of its holdings.
The tricky part is identifying outperforming stocks in advance. So modest diversification helps to spread a wider net that will hopefully catch a few more winners. However, too much diversification could dilute a portfolio’s gains.
But my best chance of success comes from researching possible investments thoroughly to gain a good understanding of each business in the portfolio.
Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.
Kevin Godbold 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.
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Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.
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