UK shares have long been a popular asset class for those seeking passive income. Thanks to products like Individual Savings Accounts (ISAs) and Self-Invested Personal Pensions (SIPPs), individuals can boost their dividend income by not having to pay a penny in tax either.
These tax-efficient products have large annual allowances. The ISA limit is £20,000, while SIPP holders can typically invest the equivalent of their yearly earnings (up to a maximum of £60,000).
However, investors don’t have to invest anywhere near this much to eventually become financially independent. Here’s how just a few hundred pounds a month could eventually generate £2,000+ in passive income
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.
Compound miracles
A modest regular investment can turn into a large pot over time thanks to the power of compounding. By reinvesting earnings, my investment grows not just from the original amount but also from the accumulated returns. This creates substantial growth over the long term.
With this in mind, what could I make if I regularly invested £300 a month? Here’s an idea based on different rates of return and investing timescales.
| 5% | 7.5% | 10% | |
| 10 years | £46,584.68 | £53,379.10 | £61,453.49 |
| 20 years | £123,310.10 | £166,119.22 | £227,810.65 |
| 30 years | £249,677.59 | £404,233.63 | £678,146.38 |
History shows us that all of these rates of return are possible by investing in global shares. But none of that’s guaranteed and I could lose money as well as making it.
But let’s take into account the middle figure of 7.5%. This is around the long-term average of FTSE 100 shares since the index was created in 1984.
With an investment pot of £404,233.63 after 30 years, I could shift my focus towards dividend-paying stocks to target a regular income.
Assuming I could achieve a 6% dividend yield, I’d earn £24,254 a year, which translates to just over £2,000 a month (£2,021, to be exact).
Where to invest?
Investors have thousands of shares to choose from in the UK and overseas. This makes building a diversified portfolio that provides a stable and decent over time much easier.
But instead of picking individual shares, investors can also choose from a number of investment trusts and exchange-traded funds (ETFs) to achieve the same goal.
These financial vehicles spread their pooled capital across a variety of assets — and in some cases across asset classes — to reduce risk and capitalise on different growth opportunities.
With this in mind, I might want to invest in a FTSE 100 tracker fund to target that 7.5% average annual return. The one I’d probably choose is the iShares Core FTSE 100 UCITS ETF (LSE:CUKX).
There are many funds like this on the market today. But with a total expense ratio of just 0.07%, this is the most cost-effective one right now.
FTSE 100 trackers like this provide exposure to blue-chip companies with market-leading positions, diverse revenue sources and robust balance sheets. And with a wide selection of constituents including banking giant Lloyds, drugmaker AstraZeneca and miner Rio Tinto, I can enjoy exceptional diversification.
Past performance is no guarantee of future returns. And a lack of appetite for UK shares could impact how much I make from the fund in the coming decades.
But with investor appetite for British stocks recovering, I think this ETF could be an excellent way to target long-term wealth, alongside my portfolio of individually selected shares.
