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How I’d start earning a passive income with £100 a month in 2021

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I’m intending to start building a passive income stream in 2021. And I plan to start with an investment of just £100 a month.

Passive income stream

I reckon it’s relatively straightforward to build a passive income stream with a set investment plan and a little patience. I say ‘set investment’ plan because I think investing my money is the easiest way to build a passive income stream.

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At present, the best savings account on the market offers an interest rate of less than 1% per annum. To generate a passive income of, say, £10,000 a year at this rate, I would need to put away £1m.

However, the FTSE 100 currently supports an average dividend yield of around 3.5%. According to my calculations, based on this rate of return, I’d need a savings pot of £285k to generate an annual passive income of £10k.

Setting up the plan

The first step on my journey is to set up a regular investment plan with an online stockbroker. Most online platforms now offer this service. It starts from as little as £25 a month and can be a great way to automate the investment process.

I think automating the process is the best strategy for me when building a passive income. Doing this will allow me to concentrate on my day-to-day work without having to spend time picking investments. It’s usually cheaper as well. Trading in and out of positions can quickly become expensive when taking into account all taxes and charges.

I plan to use a combination of the FTSE 100 and FTSE 250 to build my savings pot. The reason why I plan to use to lead index is that it’s stuffed full of blue-chip income stocks. These companies support desirable dividend yields, but their growth leaves much to be desired.

On the other hand, the smaller companies in the FTSE 250 tend to grow at a faster rate. Indeed, over the past three decades, the FTSE 250 has produced an average annual return for investors in the region of 12%. That’s compared to a return of 8% per annum for the FTSE 100.

Combined, I reckon it may be possible to achieve an annual return of around 10%.

Savings pot

Based on this projection, I think it’s possible to build a savings pot that has the potential to produce a passive income stream of £10,000 a year in two decades. This assumes my monthly contribution starts at £100 and increases at a rate of 15% a year.

Then, when my money has reached its target value, I can invest it in the FTSE 100 and look forward to a dividend yield of 3.5% every year.

What’s more, as I’m only putting away £1,200 a year to start, I can save the money in a Stocks and Shares ISA. Thanks to the tax benefits these wrappers provide, the income I earn on my final investment value will be entirely tax-free.

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Rupert Hargreaves has no position in any of the shares 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.

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