How can I earn a £500 monthly passive income by investing in UK stocks?

By focusing on dividend stocks and investing for the long term, our writer shares how they’d go about building a reliable passive income stream.

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To answer the question of how I can earn a £500 a month passive income by investing in UK stocks, let’s walk through three simple steps.

Setting clear objectives

Before making any investments, it’s crucial that I understand my current financial situation. This includes considering my income, expenses, and existing savings. Such an assessment is useful because it will help determine how much I invest each month.

I’d also carefully evaluate my risk tolerance level. The reason being that this varies from person to person and is influenced by factors like age and individual temperament. In my case, since I’ve got a long way to go before reaching retirement, my appetite for risk is relatively high.

After considering this, it would be wise for me to define my passive income goal. For the purposes of this experiment, that figure comes in at £500 per month, which equates to £6,000 a year.

Selecting the right stocks

Having assessed my finances and defined my overall goal, it would be time to pick some stocks. And since my strategy is to earn passive income in the form of dividend payments, this means seeking out well-established companies with a history of consistent shareholder payouts.

Luckily for me, the FTSE 100 is home to a number of companies that I think fit the bill. For example, take multinational insurance company Aviva with its whopping 7.63% yield.

From here, I would seek to diversify my portfolio by investing in dividend-paying companies in other industries. At the top of my watchlist at the moment are business like National Grid (5.71% yield) and Rio Tinto (8% yield).

However, it’s crucial I acknowledge the risks associated with high-yield stocks. For instance, a yield that appears attractive might be a result of a falling stock price, indicating potential underlying issues within the company.

Furthermore, unexpected economic downturns or industry-specific challenges can also impact dividend payments. This is something I’ll always need to bear in mind.

Playing the long-term game

The good news is that adopting a long-term investment horizon will help me mitigate these risks. By focusing on the long run, I’ll be well-placed to weather the storms caused by short-term fluctuations in the stock market.

On top of this, buying dividend shares and holding them for as long as possible will enable me to harness the power of compounding. That’s even after starting out from scratch.

To illustrate, let’s say I invest £600 each month into a diversified selection of dividend stocks and manage to achieve an average annual yield of 7% (a figure I think is realistic in today’s market). After nine years, I’d have a portfolio worth approximately £88,000.

From here, if I continued to achieve that 7% annual yield, I’d be bringing in around £6,160 a year in dividend income. This translates a passive income worth just over £500 per month. Not too bad at all if you ask me.

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.

Matthew Dumigan 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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