Here’s how I’d invest £10,000 a year and aim for £1,421 of monthly passive income

Passive income is the holy grail for many investors. Dr James Fox explains how he’d put his money to work to build an income-focused portfolio.

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There are many ways to earn a passive income. Lots of Britons like to invest in the housing market and become landlords. Personally, I much prefer investing in stocks and shares. While the intricacies of stocks might be more complex than buying and renting out houses, the returns can be much more appealing.

Investing regularly

If I were starting anew tomorrow, there are lots of things I’d do differently. But there are also plenty of things I’d keep the same.

One thing I’d do the same is my use of the Stocks & Shares ISA. It’s a vitally important tool for UK-based investors, allowing us to shield our profits and dividends from tax.

If I were investing £10,000 a year, or £833 a month, I’d be well within the maximum annual ISA allowance. I’m permitted to put up to £20,000 a year in the ISA wrapper.

Investing regularly is also an excellent idea. It provides my portfolio with the capacity to continue growing, and even small contributions can add up over time.

It won’t happen overnight

I’ve also got to recognise that I won’t achieve my objectives over night. One of the most powerful forces when investing is compound returns. This is essentially what happens when I earn interest on my interest. As my capital grows, my capacity to earn grows.

The thing is, bad investment decisions can also compound. And if I make poor investment decisions, I’m likely to experience losses. It’s also worth remembering that if I lose 50%, I’ve got to go 100% just to get back to where I was.

What I’d do differently

I’ve been investing for over a decade, and looking back at it, I really didn’t have much of a strategy when I started. Nowadays, I’m much more data-driven, and this has helped me achieve some really strong returns.

One stock I’ve chosen through this data-driven approach is Li Auto (NASDAQ:LI). The company may be looking a little expensive on near-term metrics compared to UK-listed stocks — it currently trades at 21.2 times forward earnings.

However, Li Auto is on an impressive growth trajectory. Earnings are expected to more than double over the coming three years. As such, the forward price-to-earnings ratios are as follows: 2024, 21.2 times; 2025, 15.7 times; 2026, 12.2 times.

Moving forward, I’d expect this momentum to be sustained. My calculations suggest the all-important price-to-earnings-to-growth ratio sits around 0.5, indicating its still vastly undervalued.

Investors may be concerned about the health of the Chinese economy and the firm’s capacity to serve international markets. However, this hasn’t proven problematic to date. Li Auto’s focus on ultra-long range hybrid vehicles has also proven hugely popular among customers wary of limited electric car ranges.

But with battery technology improving, Li has just launched its MEGA Max, touted by Li as the fastest-charging mass-produced car. The prospects, in my opinion, are strong.

So how can Li help me earn £1,421 a month? Well, it’s about the rate of growth and having a big enough portfolio. Most novice investors would be thrilled with CAGR of 10%. And if I invested £10,000 a year at 10% CAGR, after a decade, my portfolio would be generating £1,421 a month.

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.

James Fox has positions in Li Auto Inc. 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.

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