“I’ve got ninety thousand pounds in my pyjamas…” goes an old Monty Python song. As passive income strategies go, that’s a non-starter.
So get dressed, and consider a Stocks and Shares ISA instead. It would take a few years to transfer that much, with the current annual limit of £20,000. But once it’s in, it can compound for years — especially with stock market dividends reinvested in new shares. And when finally cashed in to provide income, there’s no tax to pay.
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.
So how much?
Over the past 20 years, Stocks and Shares ISA returns have averaged 9.6%. Over the longer term, something closer to 7% is more typical. Returns, including dividends, are never guaranteed. But over the long term the ups and downs tend to even out more, so let’s use 7% as an example.
A monthly passive income of £3,500 adds up to £42,000 a year. And that’s 7% of £600,000 — which is a lot more than we could realistically keep in our pyjamas, for sure. In fact, it might seem daunting. But when we do the sums, it really can start to look achievable.
Dividend strategy
FTSE 100 stocks paying dividends can be a great way to start an ISA. Companies in the top index are generally more stable and less risky than, say, small-cap growth stocks — and keeping the risk down can be very wise when starting out. And dividends can compound almost magically.
I’m going to choose M&G (LSE: MNG) as an example. Why? Mainly because its forecast 7% dividend yield matches those long-term average returns. And I also reckon a company whose business is itself saving and investing can make a good bedrock component to consider for an ISA.
M&G carries risk, even if it is a FTSE 100 giant. It crashed harder that the stock market in general in early 2020, for example. That’s why diversification’s so important. And it’s why I’d never consider investing for anything less than 10 years.
Compound miracle
How long to reach the target £600,000 depends on how much we can invest and for how long. And getting the most relies on ploughing dividends back into buying new shares.
Investing £500 a month at that rate could get us there in about 30 years, at 7% reinvested. If that sounds a lot of money each month, it’s less than a quarter of the average London flat rent.
And we’d actually have stumped up only £180,000 of the total. The rest, amounting to £420,000, comes from compounded dividends. And I’ve not even considered any possible share price rises here. M&G is up 45% in the past five years — though it’s been erratic, with the gains mostly this year.
As much as possible
How much each of us can afford to invest varies widely. If we can manage more than £500 a month, the timescale can come down sharply. But whatever we can do, seeing how dividend returns can add far more to our passive income than the money we put in has to be motivating, right?
I’m going to go check my jim jams.
