Millions of us invest for passive income, and that’s aided by the existence of the Stocks and Shares ISA — a vehicle that allows us to grow our portfolios and receive dividends without paying tax.
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.
And with an annual investment allowance of £20,000, most UK-based investors may struggle to max out their Stocks and Shares ISA.
But we don’t need to invest £20,000 a year to achieve financial freedom. Let’s take a look at the maths and how I’m aim for £63,200 of annual passive income.
Planning for the long run
Time is one of the most valuable assets when investing. This is primarily due to the power of compounding, which Albert Einstein reportedly called “the eighth wonder of the world“.
Compounding occurs when your investment returns generate additional returns over time. The longer your money remains invested, the more opportunity it has to grow exponentially.
And this is why we max out our one-year-old daughter’s pension contributions already. Small contributions can become huge portfolios over time.
So, what if I invested £200 a month? Well, here’s a breakdown of how it could look.
| 8% | 10% | 12% | |
| 10 years | £36,589.21 | £40,969.00 | £46,007.74 |
| 20 years | £117,804.08 | £151,873.77 | £197,851.07 |
| 30 years | £298,071.89 | £452,097.58 | £698,992.83 |
| 40 years | £698,201.57 | £1,264,815.92 | £2,352,954.50 |
The above chart shows the returns when our portfolios grow at different speeds — 8%, 10%, and 12%. Taking the middle number (10% growth), we can see how, with time (40 years in this case), £200 a month can grow into a huge portfolio.
So what happens when we’ve got £1.26bn in the portfolio?
Well, that’s when I’d look to shift my investments towards dividend-paying stocks. Assuming I could achieve a 5% yield, I’d earn £63,200 annually.
Where to put my money
There are several ways to invest £200 a month, but diversification is always key. I could pick one or two stocks every month or, if picking stocks monthly is a little daunting, I could look to invest in a small number of funds. Or both.
As such, I may want to consider investing in a trust like Scottish Mortgage Investment Trust (LSE:SMT).
The fund achieved notoriety during the pandemic as its share price surged and then plummeted, reflecting the value of the stocks and unlisted companies it holds.
Nowadays, the trust consistently trades at a discount to its net asset value (NAV), suggesting that by buying stock in the trust, we are gaining access to holdings like Nvidia and ASML at below market value.
Scottish Mortgage primarily invests in growth-focused industries and stocks, and this can mean it’s more volatile than funds that focus on more mature parts of the market. That’s a near-term risk worth bearing in mind.
However, Scottish Mortgage’s long-term performance is extraordinary. It’s up 288% over the last decade, despite being down 40.8% over three years.
This could be a great fund to help deliver long-term portfolio growth.
