For me, the best way to earn a passive income in through investing. It’s one of the only ways to earn a truly passive income. And it can be much more remunerative that putting money in a savings account or buy-to-let investments.
Investing vs saving
If we’re putting aside £250 a month, there are two remaining variables that will dictate how much passive income we’ll be able to receive in the future.
These are the annual returns, and the length of time we invest for. And this is where it’s important to highlight the benefits of investing versus putting money in traditional savings accounts.
Currently, the rate of annual return on a savings account is 5.22%. That’s fine, but it won’t stay there forever. And my HSBC flexible savings account has been offering me just 0.25% for most of the past decade.
So this is why I invest. I aim for low double-digit returns, while novice investors may look for 6-10% annually. And over time, this has a huge impact on the size of my portfolio. That’s because our returns compound year after year.
Compounding returns
Compound returns refer to the cumulative effect of both the initial investment and the reinvestment of any earnings or returns over time.
As profits generate additional gains, the total investment grows exponentially.
This compounding phenomenon can lead to substantial wealth accumulation, as each period’s returns become part of the base for the next, fostering exponential growth.
Compound returns reflect the power of time and reinvestment in generating wealth in various financial instruments, such as stocks or interest-bearing accounts.
So here’s how it works. Let’s imagine over 30 years my savings would generated annualised returns around 2.5%, while as an investor I could generate an annualised return of 10%.
| Savings account (2.5%) | Investing (10%) | |
| 5 years | £15,960 | £19,359 |
| 10 years | £34,042 | £51,211 |
| 20 years | £77,743 | £189,842 |
| 30 years | £133,841 | £565,121 |
As we can see, after 30 years, the investing portfolio would be four times larger than the money in a savings account.
Understanding risk
The above all sounds great, but novice investors, and even experienced investors, can make mistakes. Common mistakes include poor timing, lack of diversification, and a failure to maintain a disciplined investment strategy.
And the thing is, if I lose 50%, I’ve got to make 100% just to get back to where I was.
To navigate these challenges, investors should prioritise education, implement effective risk management, and craft a well-thought-out investment plan that aligns with their financial goals.
And that includes making the most of platforms like The Motley Fool, which have done so much to democratise the field of investing.
Personally, I use a host of resources and website for macroeconomic research, company-specific research, and the all-important data.
