It is possible to make a passive income stream from UK shares, if you’re willing to be patient. The key is to start buying shares as soon as possible and reinvest all of your dividends for long term growth.
This will allow you to make the most of compound interest, which could help you turn a small sum, such as £50, into a sizable financial nest egg.
Building a passive income
To build a passive income stream from shares, you’ll first need to accumulate a savings pot to invest. The amount you need will depend on your lifestyle and other income streams. For example, as a young investor, my income needs will be different from that of a retiree.
I’m targeting £700 a month as a passive income stream, which will cover all my housing costs. My figures show I’ll need £200k to hit this target.
An investment of £50 won’t turn into £200k all on its own. It would take 119 years for that to happen, assuming the stock market grows at an average rate of 7% a year. It’s highly unlikely I’ll live that long.
However, that £50 isn’t a one-off payment. This is a weekly deposit I’ve earmarked out of my salary. As a result, I’m putting away around £220 every month to build my passive income.
I’m planning to reinvest this money straight into the market, which should lead to immediate income potential. I’ve selected a basket of high-quality, blue-chip income stocks to invest in every month. These include defensive pharmaceutical companies such as AstraZeneca and GlaxoSmithKline, which have held their dividends throughout the pandemic.
These companies have yielded a steady total return for investors through a combination of income and capital growth in the past. I think it’s highly likely they’ll continue to do so considering the outlook for the pharmaceutical sector and their healthy profit margins. Therefore, they seem to be the perfect passive income shares.
During the past 10 years, these two companies have produced an average annual return for investors of 7%.
Around half of this return has come from dividend income. This suggests my £220 monthly contribution will yield £7.70 in income on an annualised basis. In total, I’m putting away nearly £2,640 a year. That’s enough to generate approximately £100 a year in passive income.
This isn’t the only dividend income I generate. I aim to hold a balanced spread of UK shares and globally diversified investment funds. In theory, this diversification should help shield my portfolio from any dividend cuts.
That will allow my pot to continue growing whatever the weather. Dividends should continue to roll up regardless. When dividend income is reinvested, I pick up more stock, which then produces its own dividend income. This endless virtuous circle is helping me build a passive income stream with no effort.
All I need to do it make sure I’m putting away my £50 every week. From there, I rely on the magic formula of compound growth and interest to build my passive income stream.
So, while £50 a week might not seem like enough to build a passive income stream, over time, all those little payments will add up.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended GlaxoSmithKline. 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.