Unlocking a chunky passive income is a financial goal shared by many. After all, who doesn’t love the idea of earning money without having to work for it?
Investing in the stock market is one proven method to make this dream a reality. And despite popular opinion, it doesn’t require a considerable sum of capital to get the ball rolling. In fact, with just £500 a month, investors can achieve pretty remarkable results over the long term.
Building a second salary
Many income investors like focusing on dividend stocks. These businesses are typically more mature and suffer less volatility than younger growth enterprises. As such, indices like the FTSE 100 often end up being the ideal hunting ground for income-generating opportunities.
Since its inception in 1984, the FTSE 100 has delivered an average annualised return of around 8%, half of which comes from dividends. Assuming the index continues to deliver similar a performance moving forward, investors can leverage low-cost index funds to replicate such returns with next-to-no effort.
By taking this approach, a £500 monthly investment could reach millionaire territory given enough time – even when starting from scratch. And from there, it’s just a matter of taking the 4% return from dividends as cash instead of reinvesting it. That way, even when earning a passive income, an investor’s portfolio continues to grow steadily.
| Years | Potential Portfolio Value | Potential Passive Income |
| 10 | £91,473 | £3,659 |
| 15 | £173,019 | ££6,921 |
| 20 | £294,510 | £11,780 |
| 25 | £475,513 | £19,021 |
| 30 | £745,179 | £29,807 |
| 35 | £1,146,941 | £45,878 |
Aiming higher
The prospect of becoming a millionaire earning almost £50k a year from doing nothing is undeniably exciting. However, it’s important to remember that this calculation’s based on the assumption that the FTSE 100 will continue to deliver 8% returns in the future. And lately, the UK’s flagship index has been lagging, with the average return over the last decade closer to 6%.
Six percent’s still notably higher than what savings accounts can offer. However, the 2% difference can add years to the wealth-building process. This is where stock picking can come to the rescue. Rather than relying on an index fund, investors can craft their own portfolio of individual FTSE 100 stocks, opening the door to potentially far superior returns.
Take Tesco (LSE:TSCO) as a prime example to consider. By leveraging its Clubcard scheme, price-matching budget groceries with discount retailers, and offering more premium options, the UK’s largest retailer has been slowly expanding its market share over the last couple of years.
The impact of this is made clear when looking at the group’s financials, which show revenues and underlying profits steadily rising. And when paired with a previously undervalued stock price, Tesco shares have delivered returns of almost 90% since October 2022. By comparison, index investors have only reaped 33.7% gains over the same period – not bad, but far behind Tesco.
Of course, past performance doesn’t guarantee future results. And with intense competition within the UK grocery space, Tesco’s rivals aren’t sitting still with plans to recapture their lost market share. If Tesco can’t defend its newly secured ground, then shares could slump.
Nevertheless, while it involves more risk, stock picking could be the wiser long-term move for securing a larger passive income if investors have the skill and knowledge to execute such a strategy.
This post was originally published on Motley Fool
