Some investors prefer to earn passive income today. Others opt to defer gratification. They focus instead on capital appreciation by buying growth stocks and reinvesting dividends from income shares for greater rewards down the line.
There’s no right answer to which is the right approach. That depends on each individual investor’s financial objectives and time horizon.
However, I’m a firm believer in the merits of long-term investing. So, if I had £4k to invest, I’d focus on rewarding my future self by targeting a £300 monthly passive income stream in later life. Here’s how.
A neat ISA trick
First, it’s important to consider which investment vehicle I’d select. Since I plan to hold my stocks for many years, a Lifetime ISA might be an attractive option.
I could maximise my permitted contributions in a single tax year by investing £4k in a Lifetime ISA. Subsequently, I’d receive a generous 25% government top-up on my portfolio. Accordingly, I’d have a total of £5k to invest in the stock market.
Granted, there are withdrawal restrictions if I take the money out before I reach the age of 60 and I’m not buying my first home. However, with long-term passive income goals in mind, I’d try to avoid incurring any penalties insofar as possible.
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.
Going for growth
At the outset of my investing journey, I’d prioritise capital growth over passive income. By taking on more risk in the earlier years, I’d hope to build a larger portfolio that could provide me with larger dividend payouts in retirement.
For context, the FTSE 100 index has historically returned around 7% annually since its inception. I’d aim to beat this with a high-growth investment strategy.
For instance, if I invested £5k at the age of 30, I could have a portfolio worth over £90k by the time I reach 60 with a 10.12% compound annual growth rate.
At a 4% yield, my holdings would generate my desired target of £300 in monthly passive income.
But, is a high-growth strategy risky?
Unfortunately, there are no guarantees when it comes to investing in individual shares — and often growth stocks carry significant risks as well as potential rewards. In addition, concentrating a portfolio in just a few shares would be less diversified than a tracker fund.
However, some options investors could consider include Scottish Mortgage Investment Trust — a growth-oriented fund that invests globally in public and private companies — or pharma giant AstraZeneca, which has been a top-performing FTSE 100 stock in recent years.
Rebalancing for passive income
As retirement approaches, I’d rebalance my portfolio away from growth and towards income. Therefore, a greater number of defensive investments, such as Dividend Aristocrats with reliable track records of delivering passive income, would feature in my portfolio.
Some defensive dividend stocks for investors to consider today might include cigarette colossus British American Tobacco, consumer goods conglomerate Unilever, or alcoholic drinks titan Diageo.
Of course, no shareholder distributions are guaranteed. If dividend cuts reduced my portfolio’s yield, I’d need to invest more to compensate for the loss of passive income.
Nonetheless, with a strategy of pursuing growth first and income later, I reckon I’d stand a good chance of generating a solid lifelong second income starting with just £4k.
