Passive income is something of a holy grail for investors. But the average ISA market value at the end of 2019/20 was around £6,366 for those aged 25 to 34. With all that money in shares paying a 6% yield, an investor would only receive £381 a year!
Let’s be honest, £381 isn’t going to go very far.
So, it’s clear, we need a bigger pot to generate a life-changing amount of passive income. And that’s going to take time.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
I’m now 30, and there’s a realistic possibility that I may need all my cash for a house purchase this year.
So, with no savings at 30, here’s my three step plan to aim for the equivalent of £2,000 a month in passive income.
Step 1: Regular investment
Regular investments add up over time. We all know that. But not all of us have the discipline to do this. In many respects its about making short-term sacrifices for long-term gain.
Let’s say I’m investing just £5 a day, which these days can be the price of a coffee in London. That’s £1,800 a year. And, after 10 years, without earnings any interest, I’d have £18,000.
This is obvious, but it’s just illustrative of how impactful small and regular investments can be.
Investing regularly also allows me to iron out the peaks and troughs of the market as I can buy shares when they’re cheap as well as when they’re on a high. And that’s great, because the general trend of all majors indices over the past few decades is upwards. In fact, over 30 years, the FTSE 100 has grown fourfold.
Step 2: Reinvesting
One of the best strategies for long-term gains is the compound returns strategy. This is the process of investing in dividend-paying stocks, reinvesting the dividends and earning interest on my interest. It may not sound like a winning strategy. But it is. The gains are exponential.
Here’s an example. If I invest £10,000 in stocks and achieve 10.6% in annualised returns — that’s the FTSE 250 average total returns — here’s what I’d have after five, 15, 25, and 35 years.
| Years | Pot size |
| 5 years | £16,949 |
| 15 years | £48,696 |
| 25 years | £139,903 |
| 35 years | £401,936 |
But the real gains come when I also contribute regularly.
Say I start with £0, contribute £200 a month, increase that by 5% a year, and invest in stocks and achieve 10.6% in annualised returns, it would take me 22 years to reach £300,000.
This isn’t a perfect science — it’s clearer when we use dividends only and not total returns. But broadly, it’s a winning strategy. However, I know that my stocks could underperform and returns aren’t guaranteed.
Step 3: Picking high-yielding stocks
I could just make it easy on myself and choose an index-tracking fund. But I’d rather pick my own stocks. A compound returns strategy works best with stocks paying sizeable dividends.
I believe starting with the FTSE 100, insurers Legal & General (8.5% yield), Phoenix Group (8.9% yield) are a great place to start. I own shares in both.
Moving on to the FTSE 250, I can look at banks like Close Brothers Group (7.5% yield) and Bank of Georgia (7.9% yield) — the latter is on an 18-month bull run.
With £300,000 in stocks averaging an 8% dividend yield, I’d receive £24,000 a year!
