How I’d use £5 a day to start building passive income for life

Investing small amounts regularly in high-yielding, high-quality shares and then reinvesting the dividends can make big passive income over time.

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Having my money make even more money while I do something else more interesting is the nub of the passive income idea for me.

It allows me more choice in the work I do, the holidays I take, and the opportunities I can give my family.

In short, it gives me much greater freedom in life than having to sit in an office all day trying to earn a crust.

Many people seem to think that generating passive income requires a lot of money upfront, but this is not the case.

Small amounts invested regularly in high-quality shares that pay high dividends can make big passive income over time.

A case in point

I recently bought more shares in FTSE 100 firm M&G (LSE: MNG), so will use this as an example.

Last year it paid 19.7p a share in dividends. On the current price of £2.04, this gives a yield of 9.7% — dwarfing the FTSE 100’s 3.6% average.

As great as this payout is, analysts predict that it will go even higher.

Consensus forecasts are for annual dividend payments of 20p, 20.7p and 21.3p, respectively, in 2024, 2025, and 2026.

On the current share price, this would give respective yields of 9.8%, 10.2%, and 10.5% in those years.

£5 a day to make major returns

Even with no savings in the bank, just £5 a day (£150 a month) invested at 9.7% can make a big passive income.

In the first year, the return would be £175 only, but this is just the start of the process.

To maximise the money-making potential of every penny invested, a method called ‘dividend compounding’ can be used.

This means that all dividends paid are used to buy more of the stock, which in turn creates more dividends.

Simply by doing this, the total investment pot would be worth £30,448 after 10 years, given an average 9.7% yield. This would pay £2,953 a year in passive income, or £246 every month.

On the same proviso, the pot would be valued at £320,695 after 30 years. This would pay £31,107 a year in dividends, or £2,592 monthly!

How does the business look?

A company’s dividend is powered by earnings and profits over time. If these rise, there is every chance dividends will too.

There are risks as well in all companies’ outlooks, and the same applies to M&G. The principal one in my view is that it has a debt-to-equity ratio of around 1.9.

This is higher than the 1.5 top end of the range considered good for many companies, depending on the industry. Although several investment firms use debt to finance growth, I would like to see this come down. 

However, the firm made an adjusted operating profit of £797m in 2023 – a rise of 28% from 2022. Operating capital generation also increased sharply — by 21%, to £996m.

Consensus analysts’ forecasts are for M&G’s earnings to grow at 18.8% a year to the end of 2026. Earnings per share are expected to increase by 18.2% a year to that point.

Given its huge passive income potential and growth prospects, I will be buying more of the stock soon.

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.

Simon Watkins has positions in M&g Plc. The Motley Fool UK has recommended M&g 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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