£20,000 in savings? Here’s how I’d try to turn it into a £2,987 monthly passive income

Investing in FTSE 100 and FTSE 250 shares can unlock a life-changing passive income over time, as Royston Wild explains.

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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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It’s always a good idea to have some money in a cash account. The interest these products generate provides me with a passive income, and a potentially healthy one too given the current level of savings rates.

Unlike with share investing, I know that that £1,000 invested today will still be showing in my account a year from now. I don’t have that same guarantee with equities, as stock prices famously can go up or down.

Knowing that my capital is unchanged is especially important in case I need my money for an emergency.

I have a tax-efficient Cash ISA for the reasons described above. But its ability to provide me with a second income is the least important motivation behind me holding one.

Instead, I prioritise investing in a Stocks and Shares ISA to generate a long-term passive income. Here’s why.

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.

Buying blue-chip stocks

Dividends from stocks are never, ever guaranteed. And the payouts that companies deliver can vary enormously according to economic conditions. When profits tank, dividends often follow suit.

But over the long term, the FTSE 100 and FTSE 250 indexes have proven a great way to make dividend income. With these companies also often enjoying robust capital appreciation, they have delivered some of the best returns of any asset class in recent decades.

Excellent returns

The Footsie’s long-term average annual return sits at 7.5%, while the FTSE 250‘s comes in at 11%. If this trend continues, a £20,000 lump sum investment equally invested across these indexes would turn into a healthy £317,377 over the next 30 years.

If I supplemented this with an extra £300 investment each month, I could more than double my nestegg to £896,057. And by drawing down 4% of this amount a year, I’d have a monthly income of £2,987.

By comparison, that £20k invested in a 5%-paying savings account, combined with those regular monthly top-ups, would give me £339,032. That’s half of what I could hope to make with UK blue-chip shares.

Again, that’s not a guaranteed return. But with interest rates likely to begin falling again soon, a cash account might not deliver even this sort of inferior return.

A great FTSE 100 stock

So what sort of shares would I buy? JD Sports Fashion (LSE:JD.) is a Footsie share I’m seriously considering today.

With a return north of 1,000%, it has delivered a better return than any other current Footsie share over the last decade.

Sales at the retailer have disappointed more recently, as high interest rates have sapped consumer activity. This remains a threat this year, but isn’t the only challenge it faces. It must also navigate a fiercely competitive environment to grow profits.

Yet on balance, I believe the long-term outlook for JD remains robust. The athleisure market is tipped for further growth, and the firm is steadily expanding to capitalise on this. It also has tremendous brand power thanks to strategic partnerships with sportswear powerhouses like Nike.

JD Sports shares also look massively undervalued, in my opinion. They trade on a forward price-to-earnings (P/E) ratio of just 9.7 times. This low rating gives scope for significant share price gains in the short-term and beyond.

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Nike. 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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