Building a passive income is arguably one of the most common financial goals. After all, who doesn’t love the idea of making money without having to lift a finger?
And, thankfully, the stock market serves as an excellent vehicle to achieve this objective with far less effort compared to starting a business or buying rental real estate.
Best of all, building an investment portfolio doesn’t even need much starting capital. In fact, investing just £350 a month into high-quality stocks is enough to unlock a six-figure second income. Here’s how.
Turning £350 into £133,000
Investing is often portrayed in films and the media as a fast-paced exercise with constant buying and selling. For traders, this is often the reality. For long-term investors, it couldn’t be further from the truth. In fact, most of the time, investing consists of buying shares and then waiting around for years.
That’s because while stock prices can be volatile in the short run, they ultimately represent a piece of equity in an underlying company. And businesses don’t magically grow overnight. It takes time. As such, investors need to have a great deal of patience to build a six-figure passive income.
This is especially true when working with relatively small sums of capital. In the grand scheme of things, £350 is not a lot of money. However, by tapping into the power of compounding, even small sums can be transformed into monumental wealth.
For example, the FTSE 250 has historically delivered an average annual return of 10.6% since its inception. Assuming the index continues to deliver this level of returns moving forward, investing £350 each month into a low-cost index fund could lead to a portfolio worth £2.66m over the course of 40 years. And, subsequently, transitioning this vast wealth into a hand-crafted dividend portfolio yielding 5% can hit the income target of £133,000 a year.
Income portfolios aren’t guaranteed
While 40 years is a long time to wait, investing consistently in this fashion paves the way for quite a luxurious retirement. However, as fantastic as this sounds, there are some major caveats to consider.
For starters, there’s no guarantee that the FTSE 250, or any index for that matter, will repeat their historical returns moving forward. In fact, a single percentage drop in average returns wipes out close to £700k of value from the potential portfolio!
Even if that’s not the case, the stock market has a habit of crashing every once in a while. And over the next four decades, multiple crashes and corrections will likely occur. Depending on the timing of these events, investors could end up with significantly less wealth than expected.
What’s more, after transitioning the portfolio from an index fund into dividend shares, there’s the risk that an income stock will have its cash flows compromised, ceasing shareholder payouts.
All of this is to say that the stock market is a fantastic tool for building wealth and passive income streams. Yet there are always risks that must be considered.
But a good many of these risks can be managed by taking a disciplined approach and employing strategies like diversification.