How I’d aim to turn £20k of savings into a passive income of £1,931 a month

The stock market can be an excellent source of passive income. Our writer explores a strategy to target earnings of £23k a year.

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Passive income can come in many forms. But my favourite method uses a combination of dividend shares and growth shares.

Many companies distribute cash to shareholders in the form of dividends. This can be a lucrative source of regular income.

By contrast, growth shares aren’t typically associated with income, but I’ll explain.

First steps

To achieve a second income of £1,931 a month, I’d need to build a sizeable pot. More accurately, I calculate I’d need a pot worth around £290,000.

One single £20k investment won’t be enough to reach my target though. But, diligently, investing £20k every year for 10 years could be sufficient.

This assumes I’ll earn 8% a year on my investments. There’s no guarantee I will, of course. But as it’s the long-term average over many decades, it’s a reasonable assumption to make.

If I invest money for a decade, I’d want to own both dividend shares and growth shares. By doing so, I reckon I could earn a greater return and could achieve my goal faster.

And once I’ve reached the pot size, I could sell my growth shares and focus on dividends for regular passive income.

Top growth share

One of the best growth shares right now is an intriguingly-named small beauty company called Warpaint (LSE:W7L). This is a UK-based colour cosmetics business, but it also sells its popular products across Europe, the US and more.

It’s experiencing strong growth right now across all its regions. Its affordable range includes brands W7 and Technic, and they seem to be proving popular with the 16-34 target market.

In the first quarter of 2024 sales reached £23.5m, a 28% rise from the year before. Over the past seven years, it’s grown sales by 15% a year, on average. More importantly, profits are on the up too.

With a 15% profit margin, a 22% return on capital employed, and a strong balance sheet, the business is in good shape.

Bear in mind that this is a competitive industry though. And bigger players have significantly larger marketing budgets than Warpaint.

That said, the business seems to be successfully utilising social media and partnering with genuine make-up influencers.

Strong dividend share

One dividend share I’d buy for passive income is international banking giant HSBC (LSE:HSBA). It currently offers a dividend yield of 7.3%. But as it recently announced a special dividend, its forward yield is a whopping 9.4%.

Special dividends are often temporary, so I tend to ignore them. But they can certainly provide a boost for income investors. HSBC gave this one from the proceeds of selling its Canadian business.

For dividend shares, it’s more important to look for stable business models that could be sustained for years to come. Also, a long dividend history often highlights a company’s attitude toward these cash payments. HSBC ticks both boxes.

In the near term, the outlook appears mixed. Generally, climbing interest rates were good for banks. But the next move in rates could be lower. That said, I’d still consider HSBC to be a decent long-term income share.

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.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Harshil Patel has positions in Warpaint London Plc. The Motley Fool UK has recommended HSBC Holdings. 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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