How I plan to retire early with £1,000 a month of passive income

It’s easier than you think to secure a comfortable early retirement. My plan is to build a passive income stream from dividend shares.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

The words "what's your plan for retirement" written on chalkboard on pavement somewhere in London

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Passive income is the perfect way to continue receiving an income after retirement. My pension will only stretch so far, so if I want to retire early, I’ll need something extra.

I think the best way to do this is with a portfolio of shares that pay dividends.

How dividends work 

A dividend is like a small gift that companies pay their shareholders every year as a thank-you for investing in them. A 5% dividend yield on a £1 share would pay me 5p for each share I hold. This is in addition to any returns made if the share price increases.

Dividends on shares are calculated annually, although often paid in two or four payments a year. Subsequently, my plan would involve building a portfolio of dividend shares that pay approximately £12,000 a year.

Once the passive income stream has been established, I can begin withdrawing my returns as needed.

Dividend yields change regularly, so it’s impossible to know how much I’ll receive each year. But with a portfolio of well-selected stocks, I can aim for a conservative average of around 5%.

How my strategy could work

I’ll use the small-cap iron casting and machinery firm Castings (LSE:CGS) as an example.

Its 5% dividend yield is lower than many other UK stocks but it has an excellent track record of making regular payments. I’d aim for a good mix of reliable low-yield dividend shares and less reliable high-yield shares.

Furthermore, it’s currently estimated to be trading at 58% below fair value so could go up from here. I don’t want to dive into an overvalued dividend stock that could lose value and negate any returns I make from dividends.

On the downside, Castings earnings are forecast to grow at only 3.1%, slower than the UK average of 12.6%. Still, the dividend payments make it worthwhile.

I’ve calculated that I could reach my goal of £1,000 a month in passive income in 20 years with the following strategy.

My outcome is based on a 5% dividend yield with semi-annual payments and an expected 0.2% annual dividend increase. I’ve also calculated an expected 6% annual share price increase. This is based on the past performance of an average basket of well-performing FTSE stocks.

  • First, I’d invest £12,000 into a portfolio of shares similar to Castings
  • I’d use a dividend reinvestment plan (DRIP) to put any dividends earned back into the investment
  • I’d contribute an additional £200 a month to the investment

In 20 years, my investment could have grown to £257,395. At this point, my average annual returns with dividend payments could be £12,081 – just over £1,000 a month.

Risks

There are risks involved with such a strategy. I can’t guarantee the dividend payments will be consistent, or remain at 5%. The share price of any stocks I include could also fall, resulting in financial losses.

For this reason, I need to carefully research all the stocks I add to my portfolio. I should ensure they have a solid history of growth potential and a track record of making reliable dividend payments.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Mark Hartley has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Happy young plus size woman sitting at kitchen table and watching tv series on tablet computer
Investing Articles

Could Raspberry Pi shares hit £5 by 2030?

After a strong start out of the blocks this month, our writer asks whether Raspberry Pi shares could move further…

Read more »

Close-up of British bank notes
Investing Articles

Five 5%+ yielders I’d buy for an ISA today!

Our writer identifies a handful of FTSE 100 and FTSE 250 firms each yielding at least 5% he'd happily buy…

Read more »

Front view photo of a woman using digital tablet in London
Investing Articles

5 stocks with 5%+ yields I’d love to buy and hold in a Stocks and Shares ISA

Harvey Jones is keen to add these five FTSE 100 high-yielders to his Stocks and Shares ISA, ideally before they…

Read more »

A young Asian woman holding up her index finger
Investing Articles

I’d target £880 of passive income annually, spending £10K now on this FTSE 100 share

Our writer explains how he would add to his diversified portfolio happily by investing in this FTSE 100 passive income…

Read more »

Light trails from traffic moving down The Mound in central Edinburgh, Scotland during December
Investing Articles

3 reasons I think the Scottish Mortgage share price could keep rising

Christopher Ruane explains a trio of reasons he thinks the once-mighty Scottish Mortgage share price could be set to increase…

Read more »

Syringe and vial on blue background
Investing Articles

Is this forgotten FTSE share about to make investors rich all over again?

Not long ago, this FTSE share was all the rage before demand dropped off and things went south. Is it…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

I’d use these 5 Warren Buffett approaches to build wealth

Christopher Ruane outlines a handful of investing lessons from billionaire Warren Buffett that he thinks can help a small investor…

Read more »

US Stock

Nvidia stock: 3 things investors need to know as it surges towards $150

Nvidia is a stock that's had an extraordinary run in 2024. Edward Sheldon highlights some important things investors should know.

Read more »