Key points
- Stocks and shares are a great way to earn a passive income
- An investment of just £5 a day could help build a portfolio
- These investments produce a market-beating level of dividend income
I think it is possible to earn a passive income with an investment of just £5 a day. This is about as much as many people might spend on lunch when working in the office. In some parts of London, it is also as much as some people might spend on a single coffee.
An investment of £5 a day works out as £35 a week, or just over £151 a month. For the year, I would be able to save around £1,820.
I could generate a passive income from this lump sum almost immediately. A couple of stocks in the FTSE 100 support dividends yields of 8%-10%. As such, if I were to invest all of this money in a stock yielding 10%, I could earn a passive income of £182 a year.
However, I will use a different strategy to grow my wealth before I switch to income generation.
Passive income strategy
I plan to invest in growth stocks for at least the first 10 years of saving. I think this will help me expand the size of my portfolio and could enable me to generate a higher return when I switch from growth to income.
To do this, I will invest in a portfolio of tracker funds. I believe I can achieve an annual return of around 9% using this approach. At this rate of return, I calculate I will be able to build a nest egg worth £30k after a decade.
If I switch from growth to income investing at this point, assuming I can find stocks yielding 8%, I may be able to receive a passive income of £2.4k a month.
If I keep saving, I can boost my nest egg even more. After 20 years of saving £151 a month, assuming an annual rate of return of 9%, my figures suggest I would have a portfolio worth £100,000.
By switching from growth to income when I hit this level, I estimate I could achieve an annual passive income of around £8,000.
Risks and challenges
Of course, there are a lot of assumptions in this calculation. There is no guarantee I will achieve an annualised return of 9% on my money. Nor is there any guarantee I will be able to find income stocks offering a yield of 8%, or more.
Still, I think these numbers clearly illustrate how my strategy can achieve results over the next couple of decades.
Some of the companies I would be happy to buy for my portfolio as income investments include British American Tobacco and Phoenix Group. Shares in these corporations currently offer dividend yields of 8% and 7% respectively.
As passive income investments, I believe they provide the perfect mix of income and the potential for modest capital growth as they grow and develop over the next few decades.
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Rupert Hargreaves owns British American Tobacco. The Motley Fool UK has recommended British American Tobacco. 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.
