How I’d start building passive income with only £5 a day

Not everyone has the luxury to spare large amounts of cash each week to build massive passive income streams in a short space of time. But fortunately, there are ways to generate money passively with only modest amounts over the long term. Even as little as £5 a day is enough to get started. So, how can I do this? Let’s explore.

Weighing the options

The concept of saving capital to invest in building a passive income stream is hardly new. But with so many options available, which is the best approach for me?

The easiest method is simply keeping the money in an interest-bearing savings account. In the past, this has been a reasonably lucrative option. But today, with interest rates on savings accounts sitting near zero, my money won’t stay ahead of inflation.

What about buy-to-let? This is often a popular choice for many property investors. However, with UK house prices skyrocketing, saving only £5 a day isn’t going to cut it. In other words, buy-to-let is a bit out of my targeted price range.

I’m also going to throw bonds out the window. These financial instruments let investors buy debt from companies or governments and receive interest payments for doing so. As bondholders get priority over shareholders if a company runs into financial trouble, these tend to be a lower-risk passive income strategy. But as I just said, interest rates are currently low. Therefore, unless I start buying some high-risk junk-grade bonds, the interest I’m going to potentially receive will not be meaningful.

All of those options have their virtues, of course. But with just £5 a day to spare, buying dividend stocks is my personal choice for building a passive income stream. This approach does carry more risk, as dividends can be cut or cancelled by a company at any time. Not to mention, the share price could also fall, wiping out any gains made via dividends. But on the other hand, stocks can generate substantial returns, and by diversifying my portfolio, a good chunk of the risk can be mitigated.

Saving cash to build a passive income stream

There are plenty of UK shares priced under £5, including many established enterprises in the FTSE 100 index. So, is this just a matter of picking a few solid businesses that pay dividends and buying a few shares each day? No, that wouldn’t be a particularly sensible approach because of trading fees.

Whenever I buy or sell shares, my broker takes a cut. The amount can vary, but a typical figure here in the UK is around £10 per transaction. That means if I only invest £5 at a time, my money will need to double for me to simply break even. So, to minimise the amount spent on broker fees, I want to keep the number of trades to a minimum.

By putting £5 a day aside and letting it collect, I’d save £35 in a week, which is the equivalent of £1,820 a year. By saving and investing in blocks of, say, £455, I would only need to execute four trades a year. My total annual broker fees would be £40, which means my investments would only have to rise by 2.2% to break even.

That’s far more reasonable, and with some companies in the FTSE 100 offering dividend yields as high as 8%, the cost of building a passive income stream this way could be quickly recouped.

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.