Investing £200 each month to generate a five-figure passive income may seem a bit far-fetched. Even more so considering how badly the stock market performed in 2022. Just looking at the FTSE 250, the UK index dropped by 20% over the 12-month period. And it has a long road ahead to recover.
Yet now could be the perfect time to start buying British shares. After all, diversifying an investment portfolio across high-quality businesses at low prices is a proven recipe for success. And in the long run, it could unlock a substantial second income stream.
Investing during a correction
The stock market has been through countless crashes and corrections before. And in every scenario, it has completely recovered before climbing to new highs. That’s why buying UK shares during these volatile periods can be so rewarding.
Of course, simply investing in every beaten-down enterprise isn’t a sensible idea. Investors must be selective in building their portfolios to own only the best companies listed on the London Stock Exchange. Don’t forget, while panicking investors tend to sell everything, there are some businesses worthy of disposal.
Firms with overleveraged balance sheets, unskilled management, and a weak competitive moat likely won’t deliver stellar returns. And in some cases, may even venture into a horrible realm of bankruptcy. Needless to say, that’s not the sort of stock a passive income investor wants to own.
Instead, the focus should be on finding the businesses suffering from only temporary disruptions with the financial resources available to overcome them. This approach opens the door to volatility. But this risk can be partially mitigated through diversification and pound-cost averaging. And if successful, employing this strategy could lead to market-beating returns in the long run.
Building a £20,570 passive income
Since its inception, the FTSE 250 has delivered an average annual return of 10.6%, including dividends. And that’s after factoring in the 2022 stock market correction.
Let’s assume the index will continue to generate these returns in the future. Investing just £200 monthly into a FTSE 250 index fund could build a portfolio worth £514,260 after 30 years. And following the 4% withdrawal rule, that translates into an annual passive income of £20,570.
Investors can take this one step further by picking individual stocks, which unlock the potential for greater returns. Even if a portfolio delivers just an extra 1%, that’s enough to turn the same £200 monthly investment into a £639,760 portfolio. Or, in terms of annual income, it’s an extra £5,020.
As exciting as this prospect is, it’s critical to remember that investing in the stock market is never risk-free. And when it comes to picking individual UK shares, the risk factors are only amplified. It’s entirely possible for investors to accidentally destroy wealth rather than create it. Not to mention that a crash or correction over the next three decades is likely to occur more than once.
These events will undoubtedly create buying opportunities, as the 2022 correction has done. But depending on their timing, investors may end up with a portfolio and, in turn, a passive income worth considerably less than expected.
Nevertheless, given the potential rewards, these risks are worth taking, in my opinion.
