It might sound far-fetched to turn a modest sum of £300 a month into a chunky passive income stream. But it’s not. That said, there are some parameters that I’d use to try to get there.
In summary, the key components are time and investment return. Both would be needed to reach my goal.
A long-term passive income plan
The average investment return including dividends for the FTSE 100 is around 10% a year. That calculation goes back to when the Footsie was first created in 1984.
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Bear in mind that future returns could differ. But given that this period included several recessions and a global financial crisis, I’m happy to use it as an estimate.
An equally important factor in the equation is time. By investing £300 a month in UK shares, I’m unlikely to reach my seemingly ambitious goal anytime soon. But if I set this to run continuously for the next 30 years, it becomes a much more realistic target.
With these assumptions, I’d end up with an investment pot totalling a whopping £592,178. Common industry thinking suggests that I could safely withdraw 4% of this sum every year for the rest of my life. That equates to an annual passive income of £23,687.
What to invest in?
One option is to buy a FTSE 100 index fund. This is an instrument designed to replicate the performance of this popular stock index.
Another option is to pick and choose a selection of the best shares. One benefit to this is that I could filter out any shares that I deem to be low-quality.
For a long-term portfolio, I’d look to build a diversified selection of shares. For instance, I’d want to own stocks from a variety of industries and styles. That way I wouldn’t be putting all my eggs in one basket.
History shows that small- and mid-cap shares often perform much better than large-cap stocks over time. That said, they are more volatile and less liquid. In contrast, large-cap shares can often be relatively slow and steady.
To capture these differing characteristics, I prefer to include all these types of shares in my portfolio.
Which shares?
If I had a spare £300 a month that I could devote to a long-term passive income plan, I’d buy the following shares today.
Large-cap selection: Rio Tinto, BP, Next, AstraZeneca, Experian, Diageo, and Legal & General Group.
Mid-cap selection: Games Workshop, Liontrust Asset Management, Howden Joinery, Greggs, and Vistry Group.
Small-cap selection: UP Global Sourcing Holdings, Robert Walters, Bloomsbury Publishing, and Zotefoams.
This strikes me as a high-quality, diversified, long-term portfolio. Highlighting its quality characteristics, it offers a return on capital employed of 22 and a 20% profit margin. It also benefits from a 4% dividend yield and a price-to-earnings ratio of 13.
Bear in mind that much can change in the world of business. New competition or technology might disrupt a company’s prospects. I’d need to monitor my portfolio to ensure long-term success.
