How I’d start earning a passive income with just 5% of my wages

The definition of a passive income stream is money you don’t have to work for. This might seem too good to be true. However, it’s possible to set up a passive income stream with almost no input whatsoever. 

Investors don’t even require a significant amount of money to set up a passive income. I think it’s possible to so with just 5% of my wages. 

I believe this could be the perfect approach. Taking such a small amount out of my salary every month isn’t going to have a significant impact on my financial situation. But it will have a significant impact on my passive income goals. 

Searching for income

I think the best way to build a passive income stream is to set up a portfolio with dividend stocks. Indeed, with interest rates where they are today, my figures suggest it would be virtually impossible to hit this goal without starting with a huge amount of cash. It would take as much as £1m to generate an income of just £10,000 a year on bank interest alone. 

Dividend stocks present the perfect alternative. The FTSE 100 currently supports an average dividend yield of around 3%. Some stocks in the index offer significantly more. British American Tobacco, for example, offers a dividend yield of around 8%.

By using a blend of companies in a portfolio, such as British American and its peers, I reckon it’s possible for me to build a portfolio with a dividend yield of 5%. That compares favourably to the 1% or less most high street savings account now offer. 

These dividend stocks will form the foundations of my passive income portfolio. 

Building a passive income stream

Having established the investments to buy to generate a passive income, the next stage is finding the funds. 

I’ve decided to put away around 5% of my wages a year. When combined with some small excess contributions along the way, my figures suggest I could deposit as much as £3,000 a year. 

These small deposits will add up over time. My figures also suggest that contributions of £3k a year could help build an investment pot of nearly £40k after a decade. That’s assuming an annual interest rate of 5%. 

A pot of £40k could yield a passive income of £2k a year at an interest rate of 5%. This may not be a life-changing sum, but it’s a start. It also assumes my pay remains constant over the next decade, although I think this is unlikely. Increasing my deposits by 10-20% every year would yield a pot worth £100k after a decade, according to my calculations. That could be enough to generate a passive income of £5k a year. This would be more than adequate to cover my monthly housing costs. 

That’s how I plan to start earning a passive income stream by saving just 5% of my wages every month.