Here’s how I could turn an empty ISA into £115k of passive income annually!

We’d all love to generate a passive income. But if we don’t have capital, we need to accept it’ll take time. Dr James Fox explains how he’d make it happen.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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Passive income can be generated in many ways. In the UK, it’s certainly been popular in recent years to invest in buy-to-let properties. But amid the current spike in interest rates, many landlords have struggled to pass on the higher mortgage costs of their leveraged properties to tenants.

Of course, there are other ways. My preferred method is investing in publicly listed stocks and using dividends for passive income. This is much more accessible for many Britons as we can begin with almost no starting capital. The same can’t be said when investing in buy-to-let. This is how it’s done.

Starting with almost nothing

When starting with nothing, we must accept that it’s going to take time to build a fund capable of delivering a substantial passive income. But while buying shares is a proven route for building wealth, it’s not without its risk.

If we’re yet to open a Stocks & Shares ISA, it could be a great idea to do so. It’s possible to open an account in a matter of minutes. The wrapper, which is accessible on all major platforms such as Hargreaves Lansdown, allows investors to earn an income and benefit from capital gains without paying any taxes.

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.

Discipline is key

It sounds like a Ryan Holiday book, but it’s true for investing too. Discipline is an important aspect of building a portfolio, especially when we have very little starting capital.

When starting with very little capital, we must look to regular savings — ideally monthly — to allow the portfolio to grow over the long run.

This could be aided by setting up automatic savings. This could prevent me from missing or electing to defer monthly savings commitments.

This practice also allows me to benefit from pound-cost averaging.

Compound returns

When investing, we look achieve a return, normally measured annually. This either comes in the form of dividends or share price gains, or both.

But when we invest for the long run, we can look to harness the power of compound returns. This happens when we reinvest our returns year after year.

Essentially this means we then start earning returns on our capital as well as the returns from previous years. It might not sound game-changing, but it really is, and leads to exponential returns.

The model

The below model is purely for illustrative purposes, but highlights the strength of the method. However, it’s important to note that strategy requires time, disciplined savings, and strong investment picks. If I pick the wrong stocks, I could easily lose money.

So, starting with an empty ISA, here’s how much passive income I could earn by investing just £300 a month. The calculation assumes a variety of annualised returns, ranging from a modest 6% to a Warren Buffett-esque 12%.

6% returns8% returns10% returns12% returns
5 years£1,101.66£1,538.08£2,014.37£2,534.12
10 years£2,741.83£4,054.95£5,637.38£7,543.83
20 years£7,938.31£13,391.23£21,405.97£33,178.96
30 years£17,392.77£34,114.43£64,092.20£117,784.80

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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