Wouldn’t it be lovely to have a large passive income stream one day? It certainly sounds appealing to me.
But how to get there, realistically? In stock market investing, there are arguably two classic paths. One is growth investing, and the other is dividend reinvesting.
Here, I want to take a closer look at each approach to explore how £10,000 invested each year – roughly £833 a month — can lead to annual passive income of £67,000.
Growth now, income later
This strategy is probably the most intuitive, as it centres around investing in stocks that have the potential to go up many times in value.
For example, a company’s stock price eventually might go from £1 to £10. In this scenario, an investor would turn £833 into £8,333, without lifting a finger.
A growth company usually reinvests all available cash back into the business to scale it. The risk is that it may never reach consistent profitability. In a worst-case scenario, it may even go bust.
Some red flags include rapidly slowing growth, ballooning losses, and a weakening balance sheet, including rising debt or dwindling cash reserves (or both).
However, a less obvious risk is overpaying for a stock. Take AI software firm Palantir Technologies, for example, which is exhibiting no signs of weakness. In Q1, revenue jumped 39% year on year to $884m, while it had cash and equivalents of $5.4bn.
Anyone who invested in Palantir at the start of 2023 would have made a 2,300% return!
Unfortunately, after this blistering rise, the stock is trading at 123 times sales. That’s insanely expensive. If growth slows without warning, the pullback could be painful.
Reinvesting dividends
The second approach involves buying quality dividend stocks and reinvesting income back into more shares. This would rapidly fuel the compounding process.
Legal & General (LSE: LGEN) is one such stock I do this with. The FTSE 100 firm specialises in insurance and pensions, managing over £1trn of assets.
The share price growth has been steady rather than spectacular (up just 13% in five years). But the main attraction is that Legal & General has a great track record of dividend growth.
Due to this combination of modest share price growth and growing payouts, the dividend yield is very high. Based on 2025 forecasts, the forecast yield is a mouth-watering 8.5%.
Of course, dividends are never set in stone. Legal & General is heavily exposed to the UK economy, so if something went badly wrong, the firm’s profits — and therefore dividend growth — might come under pressure.
But given the company’s strong balance sheet, I’m hopeful that I’ll be receiving — and reinvesting — dividends long into the future.
Passive income
Let’s assume an investor achieved a 10% average return on £10,000 a year. In this case, the portfolio would grow to around £1,028,134 after 25 years (excluding any platform fees).
If the dividend investor was already receiving a steady 6.5% yield, they could switch off the reinvestment tap and start enjoying almost £67,000 in annual passive income.
At this point, the growth investor could sell down growth holdings and move into dividend stocks. Assuming these collectively yielded 6.5%, the result would be the same, while maintaining the £1m portfolio.
Both strategies can work brilliantly. The keys to success are regular investing and a patient, long-term mindset.
