I like to set myself targets. Recently, I thought about how much passive income I could feasibly earn each month. It can’t be so high that I’d have to take excessive risks to try and achieve my goal. But too little, and it wouldn’t really be worth it. This made me settle on £500 per month. But can I really generate this much in passive income? After all, this is £6,000 per year.
But, with a little planning, here’s how I’d aim to achieve this through long-term investing.
Assessing my options
The first thing I need to do is buy cash-producing assets. There are many to consider, and each has its own balance of risks and rewards. Generally speaking, the higher the risk, the higher the reward (or cash flow) I may receive.
I view risk as the likelihood of not receiving cash from my assets. The higher this risk is, the greater the chance I won’t receive my passive income. Then again, I should receive higher returns to compensate for this increased risk.
To start, I could buy at a 10-year UK government bond. It pays 1.29% in interest each year right now. This is low, but I’m almost guaranteed to receive my interest from the government.
Buy-to-lets can also be a great way of generating cash flow from assets. The risk is higher because tenants may not pay rent, or the apartment might stay unoccupied for a period of time. My main issue with buy-to-lets, though, is it’s not truly a passive option. I’d have to manage repairs, bills, and any tenants. So I’m going to look elsewhere.
My favoured place to generate passive income is the stock market. I can buy shares of cash-producing companies and earn a cut of the profits. If I receive dividends, then I’m generating truly passive income.
For example, the current dividend yield of the FTSE 100 is 4%. I could buy the iShares Core FTSE 100 ETF today so I’d gain exposure to this stock index. A 4% yield is higher than the interest rate of a 10-year government bond. However, the risks are higher because dividends are certainly not guaranteed.
Based on a 4% dividend yield, I’d need a portfolio value of £150,000 to achieve my £500 per month passive income target. This may seem high, but by taking a long-term view and investing small amounts each month, I think I could achieve this.
Investments I’d make for passive income
I think I can stretch higher than a 4% dividend yield though. To do this, I’d look to buy shares of companies in my portfolio. Were I was able to, say, achieve a 5% dividend yield with my investments, I’d only need a portfolio value of £120,000.
To do this, I’d buy stocks such as Legal & General and Aviva, which both operate in the financial sector. I also own shares of Rio Tinto, Somero Enterprises and British American Tobacco so my portfolio is more diversified. It’s certainly riskier owning single stocks, but each of these companies offers at least a 5% dividend yield to compensate for this risk.
The key thing for me would be to stay consistent with my investment process and gradually build my portfolio value. Then, over time, I could hopefully achieve my £500 per month passive income target.
Dan Appleby owns shares of Aviva, British American Tobacco, Legal & General, Rio Tinto and Somero Enterprises. The Motley Fool UK has recommended British American Tobacco and Somero Enterprises, Inc. 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.
