A Medio Americano from Costa will set me back about £2.20 these days. And that’s enough to build a passive income. If I bought coffee every day, it would cost £15.40 a week, and just under £67 a month.
But rather than buy one every day, I could save the money and put £67 in a Stocks & Shares ISA every month. And that’s a great idea because it’ll put me on the road to building up a passive income for later in life.
How I’d build my passive income
With £67 a month, I can start investing straight away in my ISA. Many share funds accept a minimum regular investment of £25. So, I’d be able to spread my monthly payments between two investment funds. And each one would provide wide diversification over many underlying shares.
I could choose between tracker funds, such as those following the FTSE 100, FTSE 250, or America’s S&P 500. Or I could consider managed funds. But whatever the fund selected, I’d choose the accumulation version because it automatically rolls dividends back into my investment. And in the building stage, I want my investments to grow and compound so they can pay me a bigger passive income later.
Checking the figures on an online compound interest calculator shows how lucrative my coffee money investments could turn out to be. If my investments deliver the historical average annualised general stock market return of around 7%, I’d be happy. Compounding that rate of return for 40 years on a £67-a-month investment produces a lump sum of around £167,000 after 40 years.
And at that point, I’d switch to income investments to draw my passive income. For example, I could put the money in an FTSE 100 tracker fund and collect the dividends. Historically, the Footsie has yielded above 4% each year. But if I assume dividends as low as 4%, I’d still have a passive income of £6,680 without even drawing on my invested capital.
However, I’d increase my monthly investment sum each year just as the price of coffee goes up with inflation almost every year. So, my eventual passive income will be inflation-adjusted too.
But there’s something else I could to make my passive income really count in retirement. I could go upmarket and save the daily price of a Massimo Caramel Latte. They cost £3.65, so I’d be saving £25.55 a week, or around £111 a month.
Running the figures through the calculator shows I could end up with about £276,000 after 40 years. And that could produce a passive income of around £11,040 from an FTSE 100 tracker fund.
However, I’d go even further than that and invest more each month. And I’d also shoot for higher annualised returns from my investments by targeting a few quality shares of individual companies as well as trackers and managed funds.
Kevin Godbold has no position in any 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.