Here’s how I’d build £1,000 a month in passive income starting from scratch

Our writer looks at a way to build up a one-grand-a-month passive income stream from dividend stocks over the next 15 years.

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Whatever I want to do with my free time, having a nice flow of passive income is likely going to help. It’s why I regularly invest in shares that pay me dividends.

Clearly, it helps to have a large sum to invest upfront, but it’s absolutely not necessary. Even somebody starting from scratch can build wealth and aim for sizeable passive income.

Getting started

Whether I’m beginning my investing journey with £10,000 or £100, I’d want to invest in a Stocks and Shares ISA. The reason is that they allow me to invest £20k a year without paying tax on any gains I make.

This is obviously a massive benefit to the wealth-building process, as well as saving me the hassle of working out my annual tax obligations to HMRC.

Specifically, it means I’ll get to keep all of the future passive income my ISA portfolio generates for me.

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.

A company in great health

So, what type of stock would I buy once I’ve got my account up and running? Well, I’d focus on profitable companies that have strong competitive positions, pay generous dividends, and are trading cheaply.

One FTSE 100 stock that ticks all these boxes for me is Aviva (LSE: AV.). The firm is a major player in the UK insurance market, offering a wide suite of products including car, home, travel, and life insurance.

In its recent Q1 results, the company reported that general insurance premiums increased 16% year on year to £2.7bn. Its workplace pensions business generated net flows of £2bn as it won 136 new schemes.

CEO Amanda Blanc said: “Aviva is in great health. We are financially strong, we are trading well, and our investments in new products and customer service are paying off. We have clear competitive advantages – in our brand, our scale, and our diverse business – which are driving consistently strong performance.”

Attractive dividend and valuation

Turning to the stock, the valuation looks cheap. It’s trading on a forward price-to-earnings (P/E) multiple of 10.7, and a price-to-earnings growth (PEG) ratio of just 0.7.

The first is less than the FTSE 100 P/E average of 11, while the second is attractive because any PEG ratio under one suggests that the stock might be undervalued.

Now, I should point out that the share price is likely being weighed down by worries about a weak UK economy. Aviva could struggle to grow its profits if economic conditions remain challenging.

However, I think the risk is worth taking with the shares offering a juicy dividend yield of 7.2% for the current financial year. And while no payout is guaranteed, analysts do expect it to rise next year, giving the stock a forward yield of almost 8%.

£1k a month

Through a diverse portfolio of solid stocks like this, I reckon it’s possible to generate average long-term returns of 9%. That’s not guaranteed, mind you, and there will periods of underperformance.

But assuming I do, I’d turn £500 invested every month into £185,000 in just over 15 years. This would be with dividends reinvested.

At this future point though, I would be receiving £12,000 a year in dividends, assuming my portfolio was yielding just 6.5%. I could choose to take this as passive income or keep reinvesting to aim even higher.

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.

Ben McPoland has positions in Aviva Plc. The Motley Fool UK has no position in any of the shares mentioned. 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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