I believe passive income is an important safety net that every person should have in their life. Many years ago I discovered the hard way that life can quickly turn sour without a backup plan.
I quit my job to start a business and put all my eggs in one basket. When a third-party provider made a critical operational change, it flipped my entire business model on its head and I lost everything.
I realised at that moment the critical importance of having more than one income stream. Even just £100 a month would have made a huge difference. Fortunately, I had the support of family and friends otherwise I’d never have recovered.
So after losing everything, I taught myself how to build a slow and steady income stream (before trying any more risky business endeavours!)
Knowledge is power
The biggest hurdle limiting most people from earning money on the stock market is knowledge. When real money is at stake, it’s scary to entrust it to a system that many don’t entirely understand. The first thing I did was learn as much as I could about shares, stock markets, dividends, and investment accounts.
For example, a Stocks and Shares ISA allows UK residents to invest up to £20,000 a year tax-free! That’s a game-changer for anybody looking to earn income from stocks and dividends. I think it’s the perfect starting point for beginner investors.
The next step is understanding how different shares work and why a diversified portfolio is key.
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.
Start simple
Crafting the perfect portfolio takes years of practice and experience. Even the best investors still make mistakes now and again. Learning the basic concepts is critical, such as dividends, compounding gains, rebalancing, and risk management.
Fortunately, investment trusts provide a simple entry point for beginners. They’re essentially ready-made portfolios managed by professionals, often providing reliable returns with less risk.
One of my favourites is 3i Group (LSE: III). The trust’s portfolio is largely focused on private equity and infrastructure companies in Europe and North America. However, a single company, Action, makes up most of its portfolio, which decreases its diversification credentials.
Still, it’s up 728% in the past 10 years, delivering annualised returns of 23.5%. Based on future cash flow estimates, it’s trading at 65% below fair value. And with a price that’s 7.8 times its earnings per share (EPS), it represents good market value.
Mix it up
One stock alone isn’t sufficient to safeguard a portfolio against market dips. The 3i share price fell sharply during the dotcom crash, the 2008 housing crisis and Covid. Its bias towards Action makes it more vulnerable to economic crises, as a tightened economy potentially hurts Action’s profits.
This can be offset with highly defensive UK shares, like Unilever or BAE Systems, which tend to perform well even when other markets are struggling. Adding some dividend stocks can also help to boost returns when prices slump.
For most investors, 10% is a realistic average return. By contributing just £100 a month, the compounding returns could grow to £24,000 in 11 years. Even £2,400 of passive income a year (£200 a month) can make a difference when it matters. Naturally, some years could be more and some less — nothing is guaranteed!
The most important thing is getting started!
