Investing in stocks and shares, especially if it’s within a tax-efficient Stocks & Shares ISA, can be a financially rewarding way to create a passive income. It’s not without risks, as all investments can go down as well as up and investors can of course lose money. Yet, stock market investing, once the research is done, is much more passive than other forms of trying to make money – in my experience, at least. Dividends roll in automatically, and stop losses, for example, can be used to sell a share when it drops to a certain level, thereby reducing risk.
Anyway, I digress. What I really want to show is a plan for creating £20,000 of passive income from investing in shares.
The passive income plan
The cornerstone of my plan for creating passive income is to invest in dividend paying shares. That’s a combination of higher yielding shares, as well as those with faster growing dividends and higher dividend cover. The mix is important, in my opinion, to reduce the risk and impact of any future dividend cuts.
On top of looking for dividend paying companies, I’d also want to invest in shares that should perform above average and not be too volatile. Therefore, I’d focus my efforts on finding companies with high margins and returns on capital and that operate in steady industries such as consumer discretionary, as opposed to banking or mining, for example, which are much more cyclical.
Is it feasible?
I think the plan is entirely feasible, even for those starting with not a lot of money. Of course, in that situation it may take longer, or require more sacrifice. But it is still achievable. If I take my headline £20,000 figure and multiply it by 25, because of the number of years I might be retired for, it indicates I need £500,000. This is just a rough number, though, and passive income can be earned all through the journey of getting there. Everyone’s needs are different, but this can serve as a starting point for illustative purposes.
By investing in high-quality shares for the long term, I might be able to start with a smaller amount, thanks to compounding. For example, investing about £500 a month for 30 years would bring me to the £500,000 mark. Starting with £10,000 and raising the monthly contribution by just £50 per month and using the same timeframe results in a pot of approximately £600,000. Both these assume a return of 6%, which is relatively conservative. According to spreadbetter IG Group, the FTSE 100’s annual total return has been 7.8%. The S&P 500’s return would likely be even greater.
It takes time to create a passive income as large as this, even if non-passive sources of income grow over the years. Nonetheless, I’m confident that within my working lifetime I can, with a plan and focus, create £20,000 of passive income.
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Andy Ross owns no share 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.
Motley Fool UK 2022