My plan for an annual passive income of £12,000

Here’s my plan to set up a £12,000 passive income stream by investing £275 month in a Stocks and Shares ISA.

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Passive income is a beautiful thing. It is earnings that flow to me without my doing much at all. That is not to say I don’t have to work to set a passive income stream up. But, once set up, I shouldn’t have to do much to maintain it.

Some might strive for a buy-to-let property to generate passive income. I am aiming for a well-funded Stocks and Shares ISA. I won’t have to worry about repairs and insurance, find tenants, or chase rents with a Stocks and Shares ISA.

UK Stocks and Shares

I will need to build a substantial portfolio to generate £12,000 of passive income per year. There is no getting around that fact. As I said, passive income does not require much to maintain, but that does not say I won’t have to work to set it up. I will need to fund my portfolio, continue contributing to it for years, and let the power of compounding do its work.

According to research by IG, the average total return on the FTSE 100 from 1984 to 2019 was 7.8%. So, let’s say I have £10,000 in initial capital, and I could scrape together £275 per month to invest. Investing those amounts in a FTSE 100 tracker delivering that average return could produce a £317,976 investment portfolio after 25 years.

Now, that FTSE 100 tracker reinvested dividends, which was crucial for driving total return in this hypothetical scenario. When I am ready to start taking passive income from my portfolio, I could switch to another FTSE 100 tracker that distributes its dividends to me. Over the last five years, the average dividend yield on the FTSE 100 index has ranged between 3.4% and 4.7%. The median result of 3.8% is enough to deliver a little over £12,000 in dividend income.

Hassle-free passive income

There are a lot of assumptions baked into my plan. Can I save £275 per month for 25 years? Will something crop up that I need to dip into my passive income pot to deal with? Can a FTSE 100 tracker deliver an average return of 7.8% annually after fees? Perhaps not, but I think this is a good baseline scenario, and I can make some tweaks.

For example, I could put 50% of my funds into a FTSE 100 tracker, pick individual stocks with the rest, and try to boost my return. AJ Bell’s Q2 2022 dividend dashboard shows Rio Tinto, Glencore, Legal & General, Imperial Brands, and Anglo American have forecasted 2022 dividend yields of 13.5%, 11.6%, 7.5%, 7.5%, and 7%, respectively. Buying those stocks and reinvesting the dividends could at least lift my total returns for this year. I could also look for growth stocks to lift my returns.

And in 25 years, when it’s time to start drawing my passive income, searching for the best dividend payers again makes sense as I would like to take £12,000 from my account in dividends, but more would be better.

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.

James J. McCombie owns shares in Anglo American and Rio Tinto. The Motley Fool UK has recommended Imperial Brands. 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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