£17,000 in savings? Here’s how I’d aim for £3,375 a month in passive income

A small savings pot can go a long way towards building a passive income stream but it requires commitment. I’m considering the following strategy.

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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.

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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.

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Creating a lucrative passive income stream isn’t easy and can take a long time. However, there are tips and tricks to make the process as efficient and profitable as possible.

Maximise potential returns

The first thing I think a UK investor should do is open a Stocks and Shares ISA to benefit from tax savings. An ISA allows up to £20,000 to be invested a year with no tax levied on the returns.

For UK residents it’s easy enough to open one via a bank or through a variety of financial institutions. Read this guide for more information on a Stocks and Shares ISA specifically.

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.

Selecting the right shares

Investors typically build a diversified portfolio of growth stocks and dividend shares. Growth shares have the potential to provide better returns but can be volatile during times of economic uncertainty. For long-term stability, it’s critical to include a broad mix of shares from various industries. Consider the following two examples.

BT Group

With a yield of 7.38%, the UK’s largest telecoms company is a promising dividend stock. Although the share price has struggled for a few years, its fortunes could turn around soon. BT Group (LSE:BT.A) is transitioning the UK to a fully digital telephone network this year. 

If things go well, it stands to attract significant investor interest. If not, it could lose value.

When it comes to dividend shares, it’s important to always keep an eye on performance. If profits fall, dividends can be cut. This could require selling shares and replacing them with a more profitable stock. Since payments aren’t always guaranteed, a mix of stocks with 6-7% yields could accrue a conservative average of 5% annual dividend returns.

BAE Systems

Europe’s largest defence contractor is a well-established company with a share price up 182% in the past five years. With strong financials and a track record of consistent growth, BAE Systems (LSE:BA.) I think exhibits the characteristics of a stable and solid investment. 

Yet while dividend payments are stable, the yield is only 2.2%, so it offers little in the way of returns there.

That said, major Swiss investment bank UBS recently reaffirmed its ‘buy’ position on BAE Systems, with a target 14% above the current price. When evaluating shares, I feel it’s always good to check the positions of major brokers.

A heightened need for defence means BAE is currently doing well. During more peaceful times, demand for its services would likely drop. When assessing shares, it’s important to ascertain whether any external factors could affect the price.

Reinvestment and contributions

For maximum returns, it’s best to reinvest dividends and add monthly contributions. 

In one example, I invest £17,000 into a portfolio with an expected annual share price increase of 6% and an average 5% dividend yield. After 30 years, my investment could grow to £97,639, providing annual returns of £4,605.

That’s not bad, but it could be much more. Say I add £200 a month to the ISA and adopt a dividend reinvestment program (DRIP). In 30 years, it would be £885,626 with annual returns of £40,502 – or £3,375 a month. In 40 years it could be £2,576,480, returning £118,041 annually – or £9,837 a month!

This huge difference reveals the importance of investing as early as possible

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 positions in BAE Systems and Bt Group Plc. The Motley Fool UK has recommended BAE Systems. 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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