I firmly believe that buying stocks and shares is a great way to earn a passive income. Indeed, compared to other strategies, it is relatively straightforward to start generating income with equities.
Most people turn to buy-to-let property when looking for passive income streams. However, with the average UK property price now sitting at around £260,000, and the average buy-to-let mortgage provider requiring a deposit of at least 40%, I would need a lump sum of £104,000 to pursue this strategy.
By comparison, I can start building a passive income portfolio today with just £25. Thanks to the rise of free trading apps, I do not even have to worry about paying commission.
And using this approach, I think I can earn a passive income with a lump sum investment of £200 a month.
Investing for growth
However, investing this sum a month will not be enough to produce a substantial income stream overnight. That is why I plan to start by targeting growth stocks. By using this approach, I hope to be able to grow my savings over the next decade, or so. When I have reached a predetermined figure, I can then switch from growth to income.
The predetermined figure I have set out is £50,000. If I hit this target and invest this money in stocks yielding 8%, I can earn a return of £4,000 a year. That works out as £330 a month. This would be enough to cover roughly half of my housing costs, freeing up additional capital for me to save into my investment account.
Assuming I can earn a 10% return on my investment every year, I believe I can hit this target within 11 years. Of course, there is no guarantee I will be able to earn this return. Equity markets can be incredibly volatile, and in an economic recession, stocks could slump in value. This would derail my strategy.
Nevertheless, I believe that by focusing on high-quality growth stocks, such as Apple and Microsoft, I can improve my chances of hitting this target.
Investing for passive income
When I have hit my capital target, I can switch to investing for income. There are a couple of stocks on the market right now which offer dividend yields of around 8%. These include British American Tobacco and Persimmon. Some companies even provide double-digit dividend yields. Rio Tinto, for example, could yield approximately 16% this year.
I would buy a basket of these companies for my portfolio. By acquiring a diversified portfolio of income stocks, I think I can increase my chances of hitting my 8% per annum yield target. After all, as dividends are paid out of corporate profits, the distributions are not guaranteed. There is always going to be a chance these businesses will cut their payouts.
Still, even after taking these risks into account, I believe the above approach can help me hit my passive income target with an investment of just £200 a month.
Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Rupert Hargreaves owns shares of British American Tobacco. The Motley Fool UK has recommended Apple, British American Tobacco, and Microsoft. 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.