When I started my first office job (temping during university holidays in 1987), I think my hourly wage was at most £3. Thus, in a 35-hour week, I would make £105 before tax. After paying rent and other expenses (and partying!), I had precious little money left. Even so, I tried to put some aside, even just a few pounds a month. My goal was to build an investment portfolio so large that the passive income it generated would allow me to retire rich.
Fast-forward to today: my wife and I are both 53 and could retire immediately, should we wish. But we both enjoy our jobs — and I really love sharing my knowledge accumulated over 35 years as an investor. Therefore, let’s say I were to start out from scratch today with just £20 a week. Here’s how I would aim to replicate (and even beat) our investment success.
Building passive income from scratch
In order to start building passive income, first I need to start saving money to invest. Therefore, if I were starting out again now, the first thing I would do is invest directly from my pay. Instead of investing what’s left at the end of each month (usually nothing), I’d transfer out a monthly sum every payday. This is what’s known as ‘paying myself first’ and it’s a really powerful tool for saving. Second, to minimise my investing expenses, I’d put aside my £20 a week and invest it occasionally as larger sums. £20 a week works out to just over £1,040 a year, but I’ll round that down to £1,000. Hence, perhaps four times a year, I’d invest £250 into a single holding, aiming to hold it for the long term.
Where wouldn’t I invest?
Given that I only have around £1,000 a year to invest, I’d immediately reject several investment options. First, cash is out. As one old Russian saying goes, “He who takes no risks drinks no Champagne.” Keeping all my money in cash at near-zero interest rates won’t make me rich. Second, property is also out, because UK real estate is so expensive that it isn’t worth me investing £1,000 a year in bricks and mortar. Third, I’d also reject bonds: government and corporate IOUs that pay fixed rates of interest. After a 40-year bull (rising) market, global bonds are as expensive as they’ve ever been. Also, with coupons (interest payments) so low on bonds, they don’t generate enough passive income for my liking.
I’d buy cheap shares for extra income
With my £20 a week/£1k a year, I’d steadily build up a balanced portfolio of quality stocks and shares. In the UK, cash dividends from listed companies are expected to exceed £84bn for 2021. Hence, I’d start to build my passive income by grabbing my share of this torrent of cash. However, I know that company dividends are not guaranteed and can be cut or cancelled at any point. Therefore, I’d diversify my shareholdings, spreading my money around to reduce concentration risk.
In addition, to keep my dealing charges low, I’d invest via a low-cost online stockbroker with low minimum entry levels. And, from experience, I’d try to avoid over-trading (buying and selling share too frequently). Finally, I’d protect both my share gains and passive income from the taxman by investing inside a tax-free Stocks and Shares ISA wrapper!