How I’d try to create £105,000 in passive income by investing just £400 a month!

Dr James Fox explains how he’d use a compound returns strategy to build wealth over 35 years and generate passive income in retirement.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Middle-aged black male working at home desk

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

By investing in UK stocks, and by being patient, investors can create considerable wealth and generate life-changing passive income. For me, passive income is one of the main objectives of investing.

But I don’t need the money right now. Instead, I’m using a compound returns strategy to build wealth over the long run. After a few decades, when my pot has built up, I can start drawing down.

While the FTSE 100 offers strong returns, good quality mid-cap and even small-cap stocks can deliver big returns, unlocking sizeable income streams.

Unlocking impressive returns

The FTSE 250 is a capitalisation-weighted index consisting of the 101st to the 350th largest companies listed on the London Stock Exchange.

Over the last two decades the mid-cap FTSE 250 has provided a higher return than the FTSE 100, despite smaller dividend yields.

In fact, since its inception in 1992, the FTSE 250 has delivered an average annualised total return of 10.6%. That’s despite a correction in 2022. The index has also achieved over a 600% total return since 1998.

Compound returns

A compound returns strategy involves reinvesting my dividends and earning interest on my interest. Essentially, it’s very much like a snowball effect.

So how could I make this work when investing in FTSE 250 stocks? Well, let’s assume I invest starting with capital of £10,000 in FTSE 250 stocks, and achieve 10.6% in annualised returns. And every year, I reinvest my dividends while adding £400 a month.

Clearly, over time, my portfolio should grow in size. And the longer I leave it, the larger the pot becomes. 

YearsPot size
5 years£48,420.77
15 years£223,925.00
25 years£728,143.06
35 years£2,176,745.52

If I have the ability to leave the funds to grow for 35 years, at the end of the period I would have more than £2m.

And from here, I start taking the passive income to fund my life. A dividend yield of 5% would furnish me with £105,000 a year. That’s a pretty impressive return on a monthly investment of £400.

Naturally, there are ways I can enhance the size of my portfolio further. For one, I could increase my monthly contributions in line with inflation.

If I increased my contributions by 5% each year, after 35 years, my pot would be worth a staggering £3.25m. That’s enough to generate more than £150,000 in passive income each year.

Managing risk

The risk profile of FTSE 250 stocks can be higher than those on the FTSE 100, but that’s why I have to pick carefully.

Tough economic conditions can adversely impact smaller stocks more than larger companies. This is because smaller companies typically have fewer resources at hand to weather challenging operating environments. 

We can observe this just by looking at the performance of the indexes over the past year. The FTSE 100 is up 3% — albeit aided by surging resource stocks — while the FTSE 250 is down 15%.

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.

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.

More on Investing Articles

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »