Passive income is a major goal of mine from my share-buying activities. Here, I’m going to demonstrate how I’d try to generate a £10,000 passive income every year. With the right plan and plenty of patience, I reckon it’s possible.
Passive income from dividends
To achieve a £10,000 passive income, I calculate that I would need a lump sum of £250,000. This assumes that I can receive 4% in dividends every year thereafter. That’s a reasonable assumption, in my opinion. I hope to achieve this by investing in a basket of top dividend-paying shares.
For example, Imperial Brands, Phoenix Group, and Rio Tinto are currently trading at an average dividend yield of 7%. Importantly, the dividends are also well-covered by current earnings.
But when looking at dividends it’s important not to just pick the highest dividend-paying shares. I’d also look at whether the dividends can be sustained. A drop in earnings could affect a firm’s ability to pay shareholder dividends.
Although achieving a 7% dividend yield is currently possible, I’m going to make a more conservative assumption that I’ll receive 4% instead.
Building the pot
Before I can achieve £10,000 of passive income from dividends, I’d need to build that pot of £250,000. It may sound like a large and unachievable sum. But, let’s look at it in more detail.
The longer my time horizon, the less I’d need to invest regularly to build a £250,000 pot. Let’s assume I want to start drawing a passive income in 20 years’ time. I’d also assume that I can achieve the long-run S&P 500 return (dividends combined with share price growth) of around 10% a year. To achieve this goal, there are two options that I would consider.
- Invest a lump sum today and add no further funds
- Invest a smaller sum every month for 20 years
For the first option, I calculate that I would need to invest £37,200 today and make no further investments, simply allowing my returns to mount up. However, with the second option, I calculate that I could invest just £330 a month for 20 years instead.
To try to achieve the long-run average annual return of 10%, I’d look to invest in a basket of high-quality shares across a range of industries. Alternatively, I’d select a well-run global fund like Fundsmith Equity.
What could go wrong?
Building a passive income with such a plan isn’t guaranteed. There are several other factors to think about.
I’ve assumed I will be able to achieve the long-term average stock market return of 10% every year. This is an assumption based on past performance. But past performance might not be the actual return over the next 20 years. As there are so many factors that affect stock market performance, the real return could be smaller (or larger).
Similarly, when looking for a passive income from dividend shares, it’s important to note that dividends aren’t guaranteed either. Businesses can face shocks that affect cash flows and ultimately dent their dividends. We saw with the pandemic shock in 2020, some companies decided to suspend dividend payments as cash flows took a hit.
But I still think I can achieve a passive income from UK and US shares if I stick to a plan over a long time horizon. Let’s see if I can do it!