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How I’d generate £500 a month in passive income

Various denominations of notes in a pile
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I firmly believe that investing in stocks and shares is one of the most straightforward ways of generating a passive income for life.

I’m targeting a passive income of £500 a month using this method. This equates to £6,000 a year, and I estimate I will need a lump sum of roughly £150,000 to hit this target. This is assuming I can achieve a dividend yield of 4% on balance. 

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Of course, these are just targets. In the real world, I may not be able to achieve a 4% return year after year. I may earn more or less. It very much depends on the market environment. 

This target also excludes capital growth. While the potential for capital growth should be considered, I’m going to concentrate on my income portfolio to keep things simple for this article. 

Passive income target

The first challenge I’ll have to overcome is hitting the £150,000 lump sum target in the first place. It might seem like a simple strategy, but I’d invest in low-cost passive index tracker funds to hit this target. 

Over the past 100 years, global equity markets have produced an average annual return of around 7%. While past performance should never be used to guide future potential, this figure provides a rough estimate of the sort of returns I might see in the future. 

At this rate of return, I estimate I’d need to put away £850 a month to hit the £150k target within a decade. As returns may vary during this timeframe, the £850 mark isn’t set in stone. It’s only designed to be a rough guide. 

When I hit this target, I’ll shift to an income strategy. This could involve buying individual stocks and shares. 

A 4% yield target

It’s impossible to say which companies will yield 4% in 10 years. However today, there are a number of high-yielding stocks I’d acquire for a passive income portfolio. 

While I’m targeting a 4% dividend yield for the portfolio overall, I’d buy stocks around this target in order to provide the most diversification. After all, as they’re paid out of company profits, dividend yields are never guaranteed. 

Still, even after taking this factor into account, I’d buy high-yielding Diversified Energy and Direct Line Insurance stocks. These shares offer dividends yields of 10% and 7.3%, respectively. 

Alongside these, I’d acquire Moneysupermarket and PayPoint. Yielding between 5% and 4.8%, these companies have cash-rich balance sheets and highly profitable operations, which should support their dividends for years to come. 

And finally, I’d acquire LXI REIT, Severn Trent and Airtel Africa for my passive income portfolio. These stocks offer yields of 3.5-3.6%. Although this is below my target, I’m willing to overlook these low yields due to the solid defensive nature of their operations.

Covering property, water, and telecoms, these companies operate in defensive industries that should see continued growth over the next five to 10 years. 

Despite their potential, none of these companies’ dividends is guaranteed. Challenges such as rising wages, additional regulations and increasing interest rates could all result in dividend cuts. 

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Rupert Hargreaves owns shares of Direct Line Insurance. The Motley Fool UK has recommended Airtel Africa Plc, Moneysupermarket.com, and PayPoint. 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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