Saving £300 each month? Here’s how I’d aim for a £56k passive income

Many of us put aside money each month. But by investing this capital instead of saving, it’s possible to unlock a chunky stream of passive income.

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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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Investing’s a terrific way to earn a true passive income. There are plenty of viable alternatives, such as starting a business or buying rental real estate. But these often require a considerable upfront investment either in the form of capital or time.

Even with £300 a month to spare, building wealth and income in the stock market’s possible. In fact, given enough time, investors could end up with a £1.4m nest egg generating a £56k second income stream. Here’s how.

Unleashing the power of compounding

Since its inception in 1984, the FTSE 100‘s provided investors with an average total return of around 8% a year. At this rate, investors starting with £10,000 in the bank while topping it up with £300 each month would reach £1.4m within 41 years. And by following the 4% withdrawal rule, that translates into a £56,000 passive income.

Needless to say, it’s a pretty long wait. But it’s still an achievable milestone for those who start putting aside money early on. The problem is that there’s no guarantee that the FTSE 100 will continue to deliver this level of returns moving forward. In fact, looking at the past decade alone, the returns have actually been closer to 6%, increasing the timeline to over 50 years!

This is where stock picking may be able to come to the rescue. Instead of tracking an index, investors can take portfolio construction into their own hands, opening the door to potentially market-beating returns.

If successful, achieving average gains closer to 10%, or even 12%, could drastically shorten the wealth-building process from half a century to as little as 30 years. And for those able to wait for 50 years, a portfolio could reach as much as £15.6m!

Achieving double-digit returns

On paper, earning 12% sounds simple enough. But in practice, it can be quite challenging. Earning double-digit portfolio returns usually requires a bit of risk-taking within the small-cap space. These smaller businesses have a lot more capacity for long-term growth. But their size also acts as a handicap, given their reduced access to capital and lack of industry dominance. In other words, the higher the potential return, the greater the risk.

Looking at the London Stock Exchange today, one company that might have what it takes to deliver such gains is Treatt (LSE:TET). The speciality chemicals enterprise works with beverage and fragrance companies to develop specific sugar-free flavours and natural scents.

In recent years, the business has encountered quite a few challenges. Overstocking from the pandemic has led to material destocking in recent years, driving down demand and, in turn, volumes. But while sales continue to endure a cyclical downturn, management’s been busy optimising the business. And in its most recent results, operating margins are actually on the rise.

This cyclical pattern’s quite similar to what happened the last time we encountered a major market downturn. During 2008, demand dropped, management focused on cost disciplines, and the stock went on to deliver an almost 3,000% return by its peak in late 2021.

That’s the equivalent of a 28% annualised return. And while this level of growth’s unlikely to repeat, today’s cheap price certainly indicates tremendous potential lies ahead once conditions in the chemical market improve.

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.

Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Treatt Plc. 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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