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How I’d make a passive income with just £5 a day

Being able to live off a passive income stream from your investments might seem like an unrealistic target. However, according to my calculations, it really is possible to do this with an outlay of just £5 per day.

Five pounds a day is less than most people spend on lunch. According to research funded by the New York Bakery Co., the average Brit forks out £6.08 on lunch every day, implying an average spend of £1,550 every year. 

It is pretty straightforward to turn this lunch money into a passive income stream by investing in the stock market. 

Investing for income 

A contribution of £5 per day, adds up to a total contribution of £1,825 a year. Taking this money and investing it in a low-cost FTSE 100 passive index tracker fund would yield a total income of £82.12 per year, based on the index’s current dividend yield of 4.5%. 

In comparison to the rate of interest a saver would receive on cash savings, this is extremely attractive. You’d be lucky to get an interest rate of more than 1% on cash savings in the current environment.

As well as income from the FTSE 100, savers can also look forward to capital gains. Over the past decade, the index has produced an average annual return of around 7%, including both income and capital gains.

At this rate of return, I calculate that an annual investment of £1,825 would grow to be worth £26.5k after a decade of saving. A yield of 4.5% on this total implies a yearly income of approximately £1,193 is possible.

But there are other options available to income investors as well as the FTSE 100. You could buy a high-yield dividend fund or a basket of high-yield dividend stocks. 

Right now there are more than 30 companies in the FTSE 100 that support dividend yields of 5.5% or more. According to my figures, a basket of these stocks would yield 6.4%, producing an income of £117 for every £1,825 invested. 

Refining the basket to include only the top 20 stocks with the highest dividend yield in the FTSE 100 would push the annual average return up to 7.8%. 

Putting it all together 

With a potential average annual dividend yield of 7.8% on offer from the 20 highest-yielding stocks in the FTSE 100, you could create an annual passive income stream of £2,000 for yourself after 10 years of saving £5 per day. If you save for 20 years, I calculate it would be possible to generate an annual passive income stream of £6,500 a year based on the 7.8% yield target. 

Contributions of £10 every day would help you hit this target even faster. I calculate that saving £10 every day would put you on track to generate a passive income of £4,000 a year after 10 years and £13k per annum after 20. 

I think these figures show clearly how easy it is to build a passive income stream with a small daily contribution.

So, if you are interested in creating a passive income stream from stocks, what are you waiting for? The sooner you get started investing, the better. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.