The idea of living off passive income might sound a bit far-fetched for most of us, especially after Wednesday’s (30 October) painful Budget. Armed with some savings, however, I reckon it’s perfectly achievable with a bit of forward thinking and patience.
Savvy investing
The first step is making sure I shield as much of my money from the taxman as possible by using a Stocks and Shares ISA. This can be opened online in a matter of minutes. But the benefits of doing so can last for a lifetime.
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.
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Having done this, I can move on to creating a portfolio focused on eventually creating a monthly income.
I’m a big fan of what are known as ‘quality’ stocks. These are companies that have built up solid reputations for consistently growing earnings (and dividends) over the years. The only snag is that they tend to be a bit more expensive than most shares. However, I give an example of one that looks great value below.
Get compounding
Picking great stocks isn’t the end of it. To generate the most money I can, I must take full advantage of the secret investing sauce that is compounding.
First, I should avoid the temptation of meddling with my portfolio unless absolutely necessary. Buying and selling shares might sound exciting but it can get expensive. And all those transaction costs will be eating into any profit I can make.
Second — and this bit is equally critical — I need to reinvest the dividends I receive. Over time, this will lead to a snowball effect and more passive income coming in.
Drumroll, please!
Although nothing is ever guaranteed in the stock market, let’s say I manage to achieve an average annual return of 10% through a combination of capital growth (5%) and dividends (5%).
With £10,000 in savings to begin with, I’d be looking at a pot of just over £73,000 in 20 years. After 30 years, this will have increased to almost £200,000, generating £10,000 per year in income.
This assumes I won’t add to my savings over that period. But if I could add an extra £200 per month, that annual payout would rocket to £32,524 (or £2,710 per month)!
One stock I like
As things stand, I can see plenty of top dividend shares I’d consider buying. One example is online trading platform provider IG Group (LSE: IGG). Its share price is up 40% in the last 12 months, partly due to the volatility we’ve seen in the markets and the fact that IG benefits when clients trade more.
The current dividend yield also stands at a very nice 5.4% and looks set to be easily covered by expected profit. Looking ahead, analysts also expect the payout to increase next year. That’s exactly the sort of thing I like to see!
On the flip side, this industry is often the target for regulators. Competition is fierce too. So IG simply can’t afford to rest on its laurels if it’s to remain top dog in the space.
Then again, I think the current valuation — a low price-to-earnings (P/E) ratio of nine for FY25 — takes a lot of this into account.
