For many aspiring investors, the prospect of earning a steady £2,000 a month in passive income is the goal. It sounds great, but the challenge for many is often just getting started.
Starting investing can feel overwhelming, but breaking the process down into simple, manageable steps makes it much more approachable.
The first step involves selecting a brokerage platform that offers a Stocks and Shares ISA, such as Hargreaves Lansdown, or AJ Bell. Opening an ISA’s crucial because it allows investments to grow free from capital gains and dividend taxes, maximising the potential returns over time.
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.
The next step
Once the ISA’s set up, establishing a regular investment plan is the next logical move. This typically involves arranging a monthly direct debit to invest a fixed amount.
At first, this may involve investing straight into a fund or trust to gain instant diversification. This can be done through the brokerage. Stock picking can come later.
A popular choice for many investors is an S&P 500 ETF. For example, the Vanguard S&P 500 ETF has delivered an average annual return of around 12.5% over the past decade.
By investing a consistent sum each month, the strategy known as pound-cost averaging comes into play. This approach means more units are purchased when prices are low and fewer when prices are high, smoothing out the impact of market fluctuations and reducing the risks associated with trying to time the market.
Maths and compounding
The real power behind this method lies in compounding. Returns generated by the investments — whether through dividends, interest, or capital gains — are reinvested, creating a snowball effect. This is where earnings generate further earnings. Over time, this compounding can significantly amplify the value of the portfolio.
To illustrate, a monthly investment of £500 into an S&P 500 ETF, assuming a 12.5% annual return, could grow to approximately £480,000 in just under 20 years.
However, 12.5% as an ambitious goal. Investing in a diversified portfolio of mature UK dividend-paying stocks with an average annual growth rate of 7% would reach the same target in around 27 years.
And a £480,000 portfolio could generate £2,000 a month, assuming a 5% yield.
A first investment
If an investor is starting from scratch, I think they should first seek the diversification I mentioned above. One investment could be The Monks Investment Trust (LSE:MNKS).
This investment trust is designed as a core global growth holding, offering exposure to a diversified portfolio of companies across developed and emerging markets. Managed by Baillie Gifford, Monks prioritises long-term capital growth over income, with the current yield standing at just 0.17%.
The portfolio’s structured into rapid growth, growth stalwarts, and cyclical growth buckets, and traditionally has a bias towards small- and mid-cap companies that are often overlooked by the broader market. This differentiated approach can provide access to under-appreciated growth opportunities.
However, this strategy comes with risks. Monks has lagged its benchmark in recent years, particularly when market returns have been concentrated in large-cap technology stocks. Moreover, the trust’s focus on growth means it can underperform when growth stocks fall out of favour.
However, I’m backing it to outperform over the long run. And this was why I made it one of my first investments in my daughter’s Self-Invested Personal Pension (SIPP). It definitely deserves broader consideration.
