Passive income is essentially money made with minimal effort on the part of the individual. And for me, the best way to earn a passive income is investing.
For one, it’s much more ‘passive’ than other ways of generating income, and with a good investment strategy, investing in stocks can be relatively straightforward.
Of course, as with many things, it makes sense to start early. This means I can flatten out any short-term shocks in the market, and harness the power of compounding.
So, how can I invest my savings, let’s say £11,000, and turn it into a substantial passive income? Here’s how.
Compounding
The best way to make money while I sleep is to invest in companies that either pay a handsome dividend, or have a strong track record of reinvesting their earnings for growth.
With high-dividend-paying shares, I can reinvest my earnings thus allowing my portfolio to grow further. And this is where I can benefit from something called compounding.
Compounding essentially happens when I reinvest my returns. Thus making my portfolio bigger. The next year, I’ll be earning interest on my initial capital as well as the previous year’s interest.
It might not sound like a winning strategy, but it really is.
It’s also worth noting that many companies essentially reinvest on my behalf. Take stocks like Apple or Meta. They have a great track record at channelling earnings back into the company and growing. In turn, this means more share price growth.
Regular investment
Of course, I could really improve the pace of growth if I were to continue investing in my portfolio. This could be anything from £50 a month up to £1,666 a month if I’m using a Stocks and Shares ISA for tax efficiency.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
As highlighted by the table below, contributing £100 a month has a substantial impact over time. Below I’ve assumed an annualised growth rate of 10%. That might be ambitious for novice, but it’s certainly achievable with a well-informed investment strategy and wise stock picking.
| Starting figure | £11,000 | £11,000 |
| Annualised growth rate | 10% | 10% |
| Monthly contribution | £0 | £100 |
| Portfolio value after 30 years | £218,211 | £444,260 |
In turn, that £444,260 would have grown by £42,047 in the 30th year — that’s £3,503 a month. I could either take that as an income, or readjust my portfolio to favour only dividend-paying stocks.
Stock picking
The above all sounds great, doesn’t it? However, none of this will happen if I make the wrong investment decisions.
And capital preservation is important as legendary investor Warren Buffett tells us. If I lose 50% of an investment, I’ve got to go 100% to get back to where I was.
Currently, on the FTSE 100, I can build a portfolio of dividend-paying stocks with yields averaging 9%. In historic terms, that’s very large.
However, I also favour exposure to growth. In which case, I may want to look to the US market where more growth-oriented firms are listed.
