How should we private investors try to earn a bit of passive income for later in life? There are all sorts of approaches out there.
I go for a Stocks and Shares ISA option. The UK stock market has a long-term habit of easily beating other forms of investment.
And the gains from an ISA are free of tax. So we can invest up to £20,000 per year and not pay a penny on the profits.
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Set a target
It can be good to set targets. If we don’t know what to aim for, how can we check how well we’re doing?
Falling a bit short of reaching that £20,000 a year in passive income? How could we know if we didn’t have it as a goal? We wouldn’t be able to tell if we need to top up our investments a bit if we fall behind.
But wait. Stocks and Shares ISAs in the 2019-20 year, on average, lost a whopping 13.3%. I know people who’ve had a poor first year in shares, and it’s put them off for life.
The key is to look at long-term targets and forget what each single year does. After all, in the following year, the average return reached a positive 13.6%.
Reaching £20,000
How long might it take to reach a passive income of £20,000 a year? It depends on how much cash we can invest, and what rate of return we can achieve.
In the past 10 years, the average Stocks and Shares ISA return has come out at 9.6%. It would have beaten the pants off any savings account or Cash ISA that decade.
We’d need a shade short of £210,000 in an ISA to generate our target cash income at 9.6% a year. But I doubt the stock market will do quite as well as that every decade. So we need to model a few other rates too.
At 6% a year, for example, we’d need a bit more than £333,000 stashed in our ISA to make £20,000 each year.
Not so scary
Someone who can use their full ISA limit each year and can make that 9.6% could reach their £210,000 goal in a little over seven years.
What about someone who can stash away half that, £10,000 each year, and makes a more modest 6%? They could still hit their £333,000 goal in less than 20 years.
So put £10,000 a year in Stocks and Shares, and then sit back and enjoy a passive income of £20,000 a year? It looks possible, doesn’t it?
What to buy?
The tricky next step then, is to decide which shares to buy. I mostly go for FTSE 100 companies that pay good dividends, backed up by strong earnings and cash.
Right now, I count 38 stocks on the FTSE 100 with forecast dividend yields of between 4% and 10.5%. They won’t all pay out. But I reckon I have a decent chance of getting a set out of those with a likely average return of 6%.
