Making a passive income from buying cheap UK shares may not sound like an attractive prospect to some investors. After all, the recent stock market crash and an uncertain economic outlook have highlighted the volatility that can be present in indexes such as the FTSE 100 and FTSE 250.
However, over the long run, the stock market can provide significantly higher return prospects than other assets. Through investing regularly in high-quality companies when they trade at low prices, you could build a portfolio that provides a surprisingly large passive income.
The prospects for UK shares
While UK shares may face an uncertain near-term future, their past performance suggests they’ll go on to produce high returns in the long run. For example, the FTSE 100 has produced an 8% annualised total return over the past 36 years, despite experiencing numerous bear markets and downturns such as the market crash from earlier this year.
Certainly, investing for short-term gains may not prove to be a profitable exercise. This is due to ongoing risks from coronavirus, Brexit and other threats to the economic outlook. However, investors who have a long time horizon and who are willing to provide their stock holdings with time to grow could build a large portfolio from which to draw a passive income.
Regular investing
Regularly investing in UK shares is a sound means of building a nest egg from which to draw a passive income. It means you don’t try to time the market. This can be a difficult process due to the randomness of short-term stock market movements. It also means you invest through periods of weaker performance from stocks, thereby obtaining attractive prices ahead of likely recoveries.
For example, assuming an 8% annual return, investing £250 per month in a diverse range of shares could provide you with a nest egg worth around £340,000 in a 30-year time period. With the FTSE 100 currently yielding 5%, this would provide an annual income of around £17,000.
Not all investors will be able to buy £250 of UK shares a month, or may have a shorter time period. But the example serves to show the stock market can provide a generous passive income for regular investors over the long run.
Making a passive income
Of course, it’s important to buy a diverse range of UK shares. The uncertain outlook for the economy means some sectors and regions may experience difficult trading conditions. Therefore, having exposure to a wide range of industries and geographies may improve your prospects for a passive income.
Similarly, through buying high-quality businesses with solid financial positions and competitive advantages, you could improve your portfolio’s long-term growth outlook. You may even be able to beat the wider stock market and generate an even higher passive income by investing regularly in UK shares.
