On the surface, passive income isn’t all it’s cracked up to be. The idea sounds nice – make money with no work – but the reality is anything but.
Some ideas to make income ‘passively’ include renting out a spare room, being a landlord, or starting a business. They can be lucrative, but are these truly passive ways of making money? Hardly.
Now imagine if there was a way to earn from saved up money – higher than even savings accounts or buy-to-lets – and I didn’t need to lift a finger to do it?
Surprise, surprise
Well, this form of passive income does exist and it’s called the stock market. Investing in stocks can turn £9,000 in savings into a surprisingly large passive income stream, which I’ll share below.
Before I get to the calculation, I’d like to highlight the risks involved. Two in particular pose a threat to overenthusiastic newbies.
First, the shares I buy on the stock market can lose value at any time. Sometimes that’s because a company goes bust. Sometimes it’s because of an external event like Covid. Sometimes it’s just a Tuesday.
Anyone who can’t stand the idea of losing 20% of their net worth in a year should probably steer clear of this form of investing – as that’s a commonplace scenario!
Research
Secondly, there is nothing passive about researching a company. For example, Vodafone (LSE: VOD) looks like an attractive stock to buy. It offers the FTSE 100’s largest dividend, the share price has fallen to just 67p, and trades at around two times earnings. Time to buy?
Hang on a second. There’s a lot more going on under the bonnet of any company than can be described in two lines. Vodafone has underperformed for years, evident in its return on capital employed of around 5%, which lags competitors.
Is there any sign of a turnaround? Well, the company sold some German operations last year and is toying with the idea of selling its entire Italian segment too.
This pays for dividends and makes earnings look good – for a while at least – but isn’t the kind of strategic vision I’m looking to invest in.
Plenty more could be said about Vodafone but the point is that investing blindly is a losing strategy. I need to research the stocks I buy, or use trusted services to help me.
How much income?
If these two risks don’t put me off then I could target a 10% annual return on my cash. That’s lower than the FTSE 250 historical return, by the way.
My £9,000 would grow slowly at first but, as the years go by, would snowball into £157,044 by the 30-year mark.
That alone could give me a 4% drawdown of £6,281 yearly passive income, which I hope would last me the rest of my life.
This post was originally published on Motley Fool
