How I’d invest £3 a day to build passive income of £800 a month

I’m looking to generate a passive income in retirement by investing in a spread of top UK shares.

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I’m planning to fund my retirement by generating passive income from a portfolio of UK shares and global investment funds. I reckon it’s possible to generate income of £800 a month by investing as little as £3 a day. Here’s how I’d do it.

Investing isn’t easy, as the cost of living crisis squeezes everybody’s wallets. Yet paying £3 a day into a Stocks and Shares ISA can make a massive difference. It’s the cost of a daily cafe latte, and is a much better use of my money. I’ll happily make that sacrifice, if the reward is a healthy passive income when I finally stop working.

I’d invest in a ISA for tax-free returns

When saving for retirement, it pays to start early. If I was 25 (I wish) and starting from scratch, that £3 a day (or £90 a month) would have 40 years to compound and grow.

If I invested that amount in a diversified portfolio of UK shares and it grew at an average rate of 6% a year, it would be worth £175,200 by age 65. So how much passive income would that generate? There are two ways of calculating that.

Currently, a 65-year-old buying a single life level annuity with £100,000 would get income of £475 a month, or £5,700 a year, according to Hargreaves Lansdown. So by my reckoning, my £175,000 would buy me passive income of £831 a month, or £9,975 a year.

Most people no longer buy annuities, but leave their money invested via drawdown. If I did that instead, I would then follow the 4% rule and take that percentage of my savings as passive income each year, and leave the rest to grow.

That is known as the ‘safe withdrawal rate’. It means I can take 4% of my savings each year, without ever depleting my pot. Based on a £175,000 portfolio, that would give me passive income of £583 a month, or £7,000 a year. That’s less than the annuity but, crucially, I would still have control over my money. Also, my capital would still be there for me.

I’m actively building passive income

If I started investing for retirement at a later date, say 35, I would need to invest £5.75 a day, or £175 a month, to hit that £175,000 mark by age 65. My money would only have 30 years to grow in value. So I’d need to work harder to build the same passive income.

If I didn’t start saving until age 45, I would have to put away £12.35 a day, or £375 a month, to play catch-up. As these figures show, it’s never too early to start building up a passive income. It’s never too late either. I’d just have to work harder at it.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones doesn't hold any of the shares mentioned in this article. The Motley Fool UK has no position in any of the shares mentioned. 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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