Earning a passive income is arguably one of the most popular financial goals. At the end of the day, who doesn’t love seeing money materialise in a bank account without having to work for it?
There are a lot of different ways individuals can achieve this objective. Solutions include starting a business, owning rental real estate or, for the nerdiest among us, inventing something that generates royalties. Yet, there’s also a far easier alternative than all of these – stocks.
With as little as £5 a day, young investors can begin the compounding process of building wealth. And after enough time (like 50 years) for the snowball effect to work its magic, even this small sum can generate substantial lifelong passive income.
The power of compounding
Setting aside £5 a day equates to saving roughly £150 a month, or £1,800 a year. Investing monthly instead of daily is likely a wiser move as it reduces the number of transactions and minimises brokerage fees investors have to pay when they buy or sell shares.
Now the question becomes which shares should an investor buy? Let’s start with arguably the easiest way to put money to work in the stock market – index funds. By investing in something like a FTSE 100 tracker fund, a portfolio’s automatically diversified and rebalanced while historically delivering a robust gain of around 8% a year – half of which typically comes from dividends.
Throwing these variables into the compounding formula yields some seemingly mediocre results for the first few years. But when left to run for decades, £5 a day can transform into over a £1m portfolio!
| Year | Invested Capital | Portfolio Value | Estimated Passive Income |
| 1 | £1,800 | £1,868 | £74.72 |
| 5 | £9,000 | £11,022 | £440.88 |
| 10 | £18,000 | £27,442 | £1,097.68 |
| 20 | £36,000 | £88,353 | £3,534.12 |
| 30 | £54,000 | £223,554 | £8,942.16 |
| 40 | £72,000 | £523,651 | £20,946.04 |
| 50 | £90,000 | £1,099,759 | £43,990.36 |
Accelerating wealth building
Investing £90,000 to earn £1m is obviously an exciting prospect. However, 50 years is a long time to wait. This is where stock picking has an advantage. While investing in individual businesses requires considerably more effort and risk tolerance, it opens the door to potentially market-beating returns.
Take a company like Rightmove (LSE:RMV) as a good example. The online property portal now controls the lion’s portion of market share within the UK by quite a wide margin. However, 15 years ago, the landscape was very different. And investors who spotted the firm’s cash-flow generating potential have been rewarded with some fairly stellar returns. In fact, since April 2010, holding Rightmove shares has resulted in a total gain of 976%.
On an annualised basis, that’s the equivalent of 17.2%. And with this rate of return, the journey to a £1m portfolio with a £44k passive income doesn’t take 50 years – it takes only 27.
Today, Rightmove faces increasingly fierce competition attempting to undercut its pricing power. This isn’t the first time a business has tried to steal Rightmove’s crown. Nevertheless, it remains a risk that needs to be taken into consideration.
Fortunately, steadily declining interest rates has helped spark some fresh life into the British housing market with property listings back on the rise. That’s good news for Rightmove, especially given the firm’s track record of capitalising on cyclical rebounds.
With that in mind, despite the risks, Rightmove may be a business worth considering when looking to build long-term passive income.
