A new year often brings renewed optimism. And after seeing the stock market rally in recent months, it might be a great time to find stocks to buy.
The FTSE 250 has risen 14% since October. Inflation has cooled too. Some analysts have even predicted five interest rate cuts before 2025.
The signs are we might be at the start of a long bull run. If true, then picking up cheap shares while the markets are still trailing their peaks might be the key to a £5k passive income.
The London Stock Exchange is home to tons of companies well-suited for passive income, but it’s not as simple as throwing darts at a dartboard. Many firms direct their earnings more towards future growth. Some don’t pay any dividends at all.
These growth stocks might steal market share and dominate a sector or they might reinvest poorly. There’s a lot of instability when buying stocks like this. Perhaps worst of all, any income I receive comes from selling the shares. Timing that right is an ordeal in itself.
On the other hand, a quality dividend payer will reliably deposit money into my brokerage account. Once the research is done, I don’t need to do anything at all.
Reinvest
I already own a basket of passive income stocks. I must say, it’s a pleasant feeling to log in to my broker and find a triple-digit sum has been automatically paid into ‘settled cash’.
I can withdraw my money there and then, or I can reinvest those payments. Consistent reinvesting is how people reach million-pound ISAs or retire decades early even on relatively modest salaries.
Back to my £5k passive income then. How much will I need to invest? Well, a 5% return on dividends isn’t considered too challenging. With that return, I’d have to stump up £100k.
But that lump sum is fairly hefty. Most people don’t have it sitting around. I can work towards it though, and with a potentially lifelong £5k passive income on the line, I don’t think there are many better places for my money.
In working towards this goal, I can greatly reduce the time it takes by investing in high-quality companies. The 5% dividend sounds pretty nice, but the majority of stock market returns don’t come from dividends at all, they come through share price appreciation.
Finding the cream of the crop is sometimes easier said than done, but I can narrow down my search by focusing on high-impact metrics. A company’s return on capital is one I like. It measures how efficiently a company earns from how much it spends.
Not far away
Returns on capital are a favourite of super-investor Terry Smith who’s been called the ‘English Warren Buffett’. His fund has reached 15% returns for over a decade.
If I could build a portfolio of stocks that can achieve returns that high, I’d only need £33k for my portfolio to grow by £5k. Not all of this would be dividends of course, and this is near the upper limit of what’s possible.
But a quick calculation shows a sizable passive income isn’t too far away. With quality choices, I could invest £200 a month to reach that target in just eight years. Not bad at all.
