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How I’d invest £500 a month to make four figures a year in passive income

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Sometimes I can get ahead of myself when it comes to thinking about passive income. Of course, I’d love to make enough to retire tomorrow and spend more hours playing tennis and golf. But as an alternative, making just four figures a year in passive income would also be fantastic. Reducing the amount of income I need to make also reduces the cash I need to be investing each month, making it less of a burden on me month-to-month.

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In theory, I don’t have to just look to dividends from stocks to make me passive income. For example, Buy-to-let property and bonds are both alternatives that can offer income.

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But my preference would be to buy solid UK stocks that pay out a regular dividend a few times a year and to hold them for as long as possible. For example, take GlaxoSmithKline. The company details the dates of each quarter that the dividend will be paid. Closer to the time, the amounts will also be released. So if I buy shares in GSK today, I’ve got reliable information about the passive income that I’ll be making over time.

The main risk to using stocks to make passive income is my ‘priority’ as a shareholder. If I was a bondholder, I’d be guaranteed my coupon payments. This ranks higher than my rights as someone who owns shares. After these coupon payments, profit that’s left over is available to be paid as a dividend. But due to the pandemic, profits were severely dented and even some well-known names stopped paying dividends as they couldn’t afford it. For the record, GSK maintained a dividend over this period.

Although investing in stocks is inherently more risky, than some other investments, I feel the potential rewards are worth it. And I think I can find safer stocks that are less likely to cut or cancel their payouts.

Let’s run the numbers

Ok, so now let’s look at how an investment of £500 a month adds up. I think I can target a 6% dividend yield by investing in several top stocks (for reference, the GSK dividend yield is 6.32%). So after a year, my £6,000 pot would potentially be making me £360 a year. At the end of year three, my dividend stocks could be generating me £1,080. This four-figure annual sum is clearly very obtainable, and something that I can achieve after only a relatively short period of time.

Taking it from four figures a year to four figures a month requires more patience and time. It would take me close to 33 years to generate £12,000 a year, or £1,000 a month, in passive income. A good point to remember though is that there’s nothing stopping me getting to four figures a year and keeping going. If I don’t need the £500 for other pursuits, I may as well keep investing it for the long term. 

And if I decide to reinvest my dividends for a few years, I can take advantage of the power of compounding, building up a bigger pot for when I eventually decide to draw a passive income further down the line.

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jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline. 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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