The idea of passive income is simple: earning money without working for it.
That could be a useful way to boost my income in the short term. But over the long term, it could be an even more powerful concept.
For example, putting aside a few hundred pounds a month to invest in shares could help set up a passive income 40 years later of over £50,000 every year. That could be a helpful way to help fund retirement.
Explaining the maths
First, let’s start with how I arrived at that figure. Imagine that I put £200 each month into a share-dealing account, or Stocks and Shares ISA, then use it to invest in the stock market.
If I keep doing that and can achieve a compound annual growth rate of 8%, after four decades my portfolio would be worth around £640,000. At an 8% dividend yield, it ought to be earning me £51,562 a year in passive income.
Looking at the assumptions
Now, 40 years is a long time. How likely is it that I could achieve that goal?
One issue would be whether I could stick to my regular contribution month in, month out.
I think that would be more likely to happen with some structured approach. That is why I would consider setting up a regular contribution of a set amount, like a £200 monthly standing order.
In my example, I talked about the 8% figure in two different ways.
To grow the portfolio over 40 years, I refer to compound annual growth averaging at least 8%. That might be in the form of dividends, but it could also come from share price growth. When it comes to using the portfolio to generate passive income at a certain point though, I refer to an 8% dividend yield.
High-yield opportunities
I think both of those things are achievable. If I carefully select brilliant shares when they sell for attractive prices, I think an 8% compound annual growth rate over the long term should be doable.
As for an 8% dividend yield, I also see that as possible. Right now, shares such as Legal & General yield that much, while others I own like Vodafone are actually yielding more.
But simply chasing yield can be a costly mistake. Dividends are never guaranteed, after all, so I always focus first and foremost on finding the right quality of companies selling at the right sort of price.
Getting serious about income
Could it really be that simple? In a word, yes.
Of course, this approach to passive income involves certain expectations. I need to be willing to take a long-term approach to investing. I need to make regular contributions. If I cannot achieve my target annual compound growth rate overall, my income will be lower (though could still be substantial).
But in essence, this passive income plan strikes me as doable. It just needs patience, staying power – and action to start it.
