Building a passive income stream to enjoy later in life is possible through some simple steps. However, there are risks involved, like with all investments.
Let me break down how I would look to achieve this if I had £12,000 in savings right now.
The rules of the game
I’d open a Stocks and Shares ISA. The annual investment limit is £20,000, and any amount not used in one tax year can be rolled over to the next. Investors don’t need to pay a single penny in tax on capital gains or dividends, which is attractive.
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.
Let’s put our initial £12,000 into this ISA, and start investing in quality FTSE stocks. Naturally, I’d do my due diligence to build up a diverse portfolio of stocks to help me achieve my goal.
Next, I would also look to add £200 a month into my ISA on top of my initial investment. I’m going to do this for 30 years.
So what would I be left with? Well, using the FTSE’s average rate of return since 1984 of 7%, I’d end up with £341,942.17.
To bag my annual passive income of £13,655.69, I’d withdraw 4% each year from my total.
That equates to over £1,100 a month. I’d have paid my mortgage off by the time I’m drawing this down, my kids will be living their own lives, and I’ve also got other investments too boost my income. So this additional amount would be for me to enjoy, and live life comfortably.
I’d caveat the above by noting that the rate of return can go up and down, so there is risk involved. Plus, dividends aren’t guaranteed.
One stock to help my goals
One pick I’d happily buy if I could to help me build this additional income stream would be Admiral (LSE: ADM).
As one of the largest car insurance businesses in the country, it possesses defensive ability, in my view. This is because car insurance is a legal requirement in the UK.
Admiral’s savvy model of operating multiple brands aimed at different types of drivers has helped it grow and garner excellent profitability in the past as well. This is higher than competitors such as Direct Line, for example. However, I’m conscious that past performance is not a guarantee of the future.
One big plus point I’m a fan of is Admiral’s leading use of telematics technology, which has helped it stand out. This could continue to boost performance and returns. Telematics tech helps the business understand risks, driving patterns, and more. In turn, this has boosted the firm’s underwriting department, leading to boosted performance.
Finally, a dividend yield of 4% would help build this second income stream I’m looking for.
From a bearish view, a potential investigation by government body the Financial Conduct Authority (FCA) into inflated insurance premiums could lead to fines and reduced prices in the future. These aspects could hurt Admiral’s shares, performance, and returns. I’ll be watching this development closely.
