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Passive income involves generating revenue from activities that demand little to no active engagement or continuous effort. This could include owning rental properties, dividends from stocks, or royalties from creative endeavours. For most of us, it’s that idea of minimal active involvement for a tangible income that gets us interested.
Starting with nothing
Without any savings to my name, the concept of passive income appears distant and unattainable. Regrettably, this is the harsh truth for many individuals who have yet to utilise their ISA allowance. However, it’s entirely possible to turn an empty portfolio into one that generates a sizeable monthly income.
On the practical side, it requires me to set up a Stocks and Shares ISA — because dividends earned within the wrapper are tax-free — and it also requires me to start making monthly savings contributions. This is the only way I’ll get my portfolio to grow.
But I’ll also need to be patient, recognising that I’m not going to be able to turn my limited cash pot into a huge passive income overnight while being a disciplined saver. It may help to set up automatic savings, thus avoiding any temptation to delay, or miss, monthly contributions.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
A figure I’m comfortable with
Of course, the more money I contribute every month, the quicker my portfolio should grow. But I need to find a figure that I’m comfortable with. There’s certainly little point over-contributing and then having to withdraw money from the account.
It all depends on how much disposal income I have after tax, pension contributions, and other expenses. I may want to start by looking to invest just 5% of my monthly income. In the case of most Britons, this would be around £100 a month.
As is often the case with sensible investing strategies, my plan revolves around compound returns. This is a strategy that requires investors to reinvest their returns every year, thus allowing a portfolio to grow exponentially.
A mathematically satisfying way to calculate this is by using stocks that offer little in the way of share price growth but have strong dividends. However, it’s equally the case that a compound returns strategy would work with companies that do the reinvesting for us.
Take some of the biggest US tech stocks like Apple. It offers a tiny dividend, but reinvests its profits every year and, to date, has achieved impressive growth rates. Of course, when it’s time to start extracting money from the portfolio, I may prefer to invest in dividend stocks.
How much could I earn?
Let’s assume I’m investing £100 a month in my portfolio. The two remaining variables are time and annualised returns. Naturally, the longer I leave it, and the better my investments perform annually, the more money I’ll have in my portfolio, and the greater the interest it can generate. Stock picking really is key. Choose poorly and I could lose money.
Here’s how much passive income I could generate annually by investing just £100 a month and with varying rates of return. At the top end of the scale, I could be earning as much as £3,271.80 every month!