Investing in cheap shares can be a terrific way to unlock a regular passive income in the long run. Investors don’t necessarily have to stick to dividend shares to achieve it, nor does it require huge amounts of capital. Instead, drip-feeding relatively modest sums, such as £500 each month, can be all it takes to earn a potential chunky second income stream. Here’s how.
Buy low, sell high
Investing consistently in the stock market is a proven strategy for building long-term wealth. And best of all, allocating capital to something as simple as a low-cost index fund can be all that it takes.
For example, the FTSE 100 has historically delivered an average return of 8% per year since its inception. At this rate, investing £500 a month over a period of 30 years and reinvesting returns translates into a total portfolio value of £745,180. And by following the 4% withdrawal rule, this is sufficient to generate close to £30,000 per year passively.
Alternatively, instead of relying on an index fund, investors can opt to pick individual stocks. This obviously involves far more effort, time, and dedication. After all, stock picking demands a lot of research and preparation that simply isn’t needed when following an index investing strategy.
However, by hand-selecting fantastic businesses trading at dirt cheap prices, it’s possible to unlock market-beating returns. Even if it’s just an extra 2% per year, that’s enough to push the portfolio value to £1.13m or the passive income to £45,200 per year!
Investing can be risky
Nothing is ever guaranteed in the stock market. The FTSE 100 may not continue to deliver 8% returns over the next three decades. And stock picking, when executed poorly, can spectacularly backfire. A poorly built or managed custom portfolio may end up lagging the market benchmark. It could even destroy wealth.
As such, when 2053 comes around, investors may have considerably less than expected in the bank. Fortunately, there are a few tactics stock pickers can use to mitigate downside risk. The most critical is due diligence.
Chasing the hottest stock picks rarely ends well, nor does focusing on the most popular shares to buy. Instead, investors have to spend time researching both the risks and potential rewards offered by a company to make an informed investment decision – something that The Motley Fool’s Share Advisor service can help with.
But even after digging into the details, an unforeseen external factor can still come in and turn things upside down. That’s where prudent portfolio planning enters the picture. By staying within personal risk tolerance limits, an investor is more likely to achieve their goals. And while the final portfolio value may still fall short of a target 30 years from now, the added wealth potentially created over this period is still worthwhile pursuing.
