I have a friend who wants to invest to set up a bit of passive income. Not for himself, but for the future of his kids.
I think that’s a great outlook. And it helps give him the long-term focus that many people these days seem to lack.
People ask me for get-rich-quick stock tips, and I always have to disappoint them.
When I tell them I can’t do better than throwing darts at the Financial Times, that ruins my ‘investment expert’ status in their minds. But it keeps them off my back.
Long term
But when someone is talking about long-term investing for passive income, then I’ll offer all the help I can.
Sometimes they’re disappointed when I can’t tell them which stocks to buy. But, we have to make our own investment choices. And all I can do is explain some facts, and offer some thoughts on strategies, to try to help them make their own decisions.
My friend has about £8,000 saved, and can add to it. So, the first thing I’d point out to him is that the UK stock market has wiped the floor with other forms of investment for more than a century.
I’d also make it clear, though, that there’s no gurantee that future returns will be the same as past returns.
120 years
But, saying that, over the past 120 years, UK stocks have made average annualised returns of about 4.9% above inflation.
As it happens, City of London Investment Trust (LSE: CTY) is on a 4.9% dividend yield. Oh, and it’s raised its dividend for 57 years in a row.
So what if we put £8,000 into that, and the share price rises by the Bank of England’s long-term inflation target of 2%. That should match stock market history quite nicely.
Left there for 30 years, with dividends used to buy more shares, it could grow to nearly £60,000. Compounding really can help build up our returns over the years.
And, it’s without a single extra penny added.
Add more cash
What about another £5,000 each year at the same returns? In 30 years, we could end up with half a million pounds! And that could get us 30 grand a year in passive income.
And what a time to start, with a brand new Stocks and Shares ISA allowance of £20,000.
This all leaves us with the tricky question of what shares to buy. And that has to be down to individual choice. We need to choose a strategy that we understand and are comfortable with.
Diversification
I rate diversification as essential, and I get a good bit of that from an investment trust like City of London. It holds BAE Systems, Shell, HSBC Holdings, and a lot more top FTSE 100 stocks.
It still has risk, and if it fails to up its dividend one year then the share price could suffer. The trust invests for a mix of income and growth, and some of its stocks don’t pay much at all. And, in a tough year, the balance could be critical.
So I’d definitely diversify futher. And then hold for the long term.
