Some investors prefer to invest in growth stocks in the hope their share prices will appreciate at a faster rate than the market average. However, for those who prioritise generating a second income, buying dividend stocks is a more suitable strategy.
But, if I had no savings, could I really secure passive income for life if I set aside just £5 a day to invest for the long term?
Yes, I believe so. Here’s how I’d approach that goal.
Look after the pennies
Disciplined saving habits are the core building block of a successful investment strategy. Putting aside a fiver a day might seem challenging in this inflationary climate, but many of us still incur avoidable costs.
Whether it’s cancelling unused subscriptions, giving up takeaways, or opting for cheaper phone deals, those little savings add up over time.
Saving £5 a day equates to £1,825 a year. By keeping this up over decades, I’d be on my way to building a sizeable passive income portfolio in time for a well-deserved retirement.
Dividend investing
Saving regularly isn’t enough by itself if I want to earn a lifelong second income. Considering the UK’s CPI inflation rate is currently 8.7%, if I parked my savings in cash, it’s likely my portfolio would lose its purchasing power over time.
That’s why I need to invest in the stock market. Now, it’s important to note that returns from shares aren’t guaranteed. There have been prolonged periods when stocks underperformed inflation. Indeed, poorly chosen investments sometimes never recover. So, it’s fair to say investing in stocks demands a risk appetite and tolerance for volatility.
Nonetheless, using history as a guide, buying shares for the long run has been a good way to protect a retirement pot’s value from inflation’s corrosive effects. According to IG Group, for the past 119 years UK stocks delivered annualised returns of 4.9% over and above inflation.
Currently, the FTSE 100 yields 3.8% and the FTSE 250 yields 3.5%. However, both indexes contain several companies that don’t pay dividends. Accordingly, it’s possible to boost my portfolio’s yield by concentrating it exclusively in dividend shares.
Examples of some I own include:
- Lloyds Bank — 5.7% yield
- Centamin — 4.3% yield
- Tesco — 4.4% yield
Compound returns
If I started saving and investing £1,825 every year at the age of 27 and my portfolio grew at a compound annual rate of 5% in real terms from capital appreciation and dividend reinvestments, here’s what my journey could look like.
| Age | Portfolio value |
|---|---|
| 37 | £27,075 |
| 47 | £68,204 |
| 57 | £135,201 |
| 67 | £244,331 |
At a 4% dividend yield, my nest egg would produce £9,773 in annual passive income by the time I’m 67. Adding the State Pension (currently £10,600 a year) boosts this figure to a respectable £20,373.
Plus, with a time horizon spanning four decades, I could use a Self-invested Personal Pension (SIPP) for my portfolio to capitalise on tax relief. In doing so, my portfolio value and ultimate dividend income would likely be larger.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Although the growth rate and dividends aren’t guaranteed, I’ve used reasonably conservative estimates for my calculations. If stocks continue their upwards trend — in line with bygone years — earning a second income by investing just £5 a day is a realistic ambition.
