If I had £11,185 in savings, and could supplement it with a modest monthly investment, I’d seek to generate long-term passive income by buying FTSE 100 stocks.
The figure I’ve mentioned hasn’t been plucked out of the air. According to Finder, it’s the average amount that a UK adult has in cash savings.
Coming up with a plan
In my opinion, the Footsie is home to many profitable and cash generative businesses that makes its stocks particularly attractive to me.
But there are no guarantees when it comes to investing. Broadly speaking, the stock market reflects the health of the global economy, which, as history shows, goes through many peaks and troughs.
However, the past also tells me that a portfolio of carefully chosen shares could help me earn significant passive income over the longer term.
Looking into the detail
In my view, the best way to start investing is by opening a Stocks and Shares ISA. That’s because all income and capital gains are free of tax.
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.
I’d then look to buy four or five stocks. Experienced investors know the advantages of diversification. Choosing only one stock would make my portfolio entirely dependent upon the performance of a single company. That business could do well but, then again, it might not.
Before deciding what to buy, it’s important to do some research.
I like to read a company’s most recent annual report to see if there are any potential red flags. This also helps me understand more about the markets in which it operates.
In addition, I use common valuation measures like the price-to-earnings (P/E) ratio, to help identify whether a company is fairly valued.
Putting my money where my mouth is
That’s how I made the decision to include Legal & General (LSE:LGEN), the FTSE 100 financial services provider, in my ISA.
Analysts are expecting earnings per share of £24.66 in 2024. This implies a forward P/E ratio of 10, which is below the index average.
I also think it has an excellent opportunity to benefit from a growing demand for its pension risk transfer services.
Higher interest rates have helped move many pension schemes from a deficit to a surplus. Trustees are now seeking to take advantage and reduce their risk exposure by selling these to a third-party provider, like Legal & General.
The company makes money by charging a fee on the initial amount transferred. It then reinvests the funds hoping to earn more than it has to pay in pensions. It estimates there’s a pipeline of £250bn of schemes that are looking to be sold on.
I was also attracted by its generous dividend. The stock currently yields 8.3% — comfortably above the Footsie average of 3.9%. I’d use this income to buy more shares.
Legal & General operates in a highly competitive market and is sensitive to fluctuations in the wider economy. But despite this — by taking a long-term view — I think it could help me match the average annual growth rate of the FTSE 100 since its launch in 1984, of 8%.
Assuming this continues for another 25 years, an initial lump sum of £11,185 — boosted by an additional £300 every month — would turn into £369,310. Drawing down 5% of this each year would give me annual passive income of £18,466.
