My earliest attempt at building a passive income was a complete failure. I naively and optimistically put a few thousand pounds into a savings account with the hopes I’d get a decent chunk of cash back. My first month’s interest was about 40p. Safe to say, I wasn’t impressed.
Throwing my life savings into a 0.5% interest account wasn’t my only mistake, but I’ve had a lot of success too. I’ve since watched the cash I invest multiply far more than I could get through cash savings or even property. I’m now on course to withdraw a sizable passive income one day that would never have been possible with other investments.
Let’s say I was starting today with £100 and I wanted to build a passive income without wasting years spinning wheels and getting subpar returns. So here’s what I’d do to target a £11,687 yearly passive income.
What to do
My first step would be to open a Stocks and Shares ISA so I can invest in the stock market. This would have sounded crazy to my younger self. After all, I’d only ever seen the stock market on television or in documentaries, usually where smooth-talking Americans lose millions of dollars. It seemed risky and not something I wanted a part of.
What changed my mind was seeing how much money could be made with stocks. The MCSI World Index – like a tracker for the major stock markets of the globe – has grown at 10.6% on average in recent decades.
Other investments struggle to match that return, and aiming for 10% or more is the cornerstone of many passive income strategies.
An eye on an income
And while 10% a year sounds like a decent chunk of change, it’s hard to overstate how rapidly the cash grows over long periods. To take an example, if I save £100 each month for 30 years, I end up with £36,000. Not too bad. But it won’t provide much in the way of a passive income.
| Saving | |
| 1 year | £1,200 |
| 5 years | £6,000 |
| 10 years | £12,000 |
| 20 years | £24,000 |
| 30 years | £36,000 |
But if I save that exact same amount and add 10.6% each year in the form of interest, I end up with £233,743. My investments reach as high as they do – over six times the amount I put in – through the compounding effect as I get ‘interest on the interest’.
| Saving | Investing | |
| 1 year | £1,200 | £1,268 |
| 5 years | £6,000 | £7,833 |
| 10 years | £12,000 | £20,797 |
| 20 years | £24,000 | £77,753 |
| 30 years | £36,000 | £233,743 |
When it’s time to enjoy my passive income, I’d withdraw a smaller amount. Something like 5% can be achieved through dividends – many FTSE 100 stocks offer a higher return – which could bring me a passive income of £11,687 each year.
As nice as working towards a passive income sounds, there are no guarantees here. Past performance is not guaranteed to continue, and I can lose money investing this way. On balance though, I feel there is no better place for my money.
Passive income it is, then!
