Most forms of passive income turn out to require quite a bit of effort. If I buy a rental property, I’d need to attract tenants (some of whom may turn out to be problematic) and deal with maintenance issues along the way.
To sell items online, I’d need to source and store them, write listings, pack and post everything… the list goes on.
Investing in the stock market is a whole different matter. Having picked a selection of dividend-paying shares, I can theoretically sit back and wait for cash to be paid into my account.
So how much would I need to generate £500 every month?
Passive income plan
A good place to start is the FTSE100‘s dividend yield. At the time of writing, this stands at 3.9%. To get the equivalent of £500 per month, I’d need to build a total pot of £153,846.
Now, that might sound like an awful lot of money to an investing newbie. However, I think it’s achievable if a person has decades to go until retirement and can put some money aside every payday.
If I put £200 to work every month for the next 25 years, and my investments grew by 7% each year, I’d be very close to my goal.
Not needing any income generated over that period would boost things. Instead of spending it, those dividends can be reinvested right back into the market.
Think of it like a snowball rolling down a hill and growing in size. Theoretically, the more shares I own, the more passive income I receive.
Of course, funneling increasing amounts of fresh cash into my Stocks and Shares ISA once the saving habit has stuck wouldn’t do any harm either!
There are other ways of speeding things up, albeit involving more risk. Some individual stocks in the FTSE 100, for example, offer forecast yields of over 10%! So I’d actually need a smaller pot than £153,846 to generate the same level of passive income.
Buyer beware
Regardless of my approach, there are a few things any income investor needs to be aware of.
First, no dividend stream is guaranteed. In fact, those 10%+ yields mentioned could actually be a signal that a cut is imminent. If it looks too good to be true, it probably is.
One way of protecting myself is to find firms that have great track records of returning cash to their owners. Safety tech juggernaut Halma, premium spirit seller Diageo and defence giant BAE Systems are examples. The only snag is that they yield far less than 10%.
It’s also prudent to hold stocks from a variety of sectors. This way, those companies in parts of the market that are thriving should make up for those that aren’t (and possibly reducing their payouts).
Third, dividends aren’t paid on a monthly basis. In fact, the vast majority of companies return cash twice a year. Hence, investors shouldn’t expect amounts to be the same every month.
No time to lose
These caveats aside, I remain convinced that the stock market is one of the few true sources of passive income out there.
As we often reflect at Fool HQ, the secret is no secret. Just get started.
