Making a passive income could be simpler and more accessible than many people realise. After all, the process of setting up a tax-efficient account such as a Stocks and Shares ISA, buying dividend shares and holding them for the long run is relatively cheap and straightforward.
Through investing regularly, it is possible to build a surprisingly large nest egg over the long run that provides a generous income return. It could improve an individual’s financial position over the coming years.
Opening a Stocks and Shares ISA
A Stocks and Shares ISA is a sound means through which to generate a passive income. It can be set up online in a matter of minutes. And it provides tax efficiency versus a bog-standard share-dealing account. Moreover, management fees for an ISA are no more than the cost of a single trade in many cases. Regular investment services are often available on ISA accounts too. That means investors with limited funds can benefit from the income opportunities provided by the stock market.
A Stocks and Shares ISA also provides greater flexibility than other tax-efficient accounts such as a SIPP. Withdrawals from an ISA can be made at any time and without penalty. That is often not the case with other types of accounts. This may make them especially useful to those seeking a passive income, but wanting access to their capital in case of emergency.
Investing in dividend shares for a passive income
Making a passive income is more difficult now than it has been in previous years due to low interest rates. But dividend shares continue to offer high yields in many cases. For example, the FTSE 100 contains a wide range of businesses with 5%+ dividend yields at present. Buying a diverse range of such stocks could be a sound means of making a worthwhile income. And it could limit the risk of loss should any holdings meet challenging operating conditions.
Furthermore, buying dividend shares that have the capacity to raise their shareholder payouts could be a sound move. They may pay out a lower proportion of profit as a dividend than their peers, or could have sound profit forecasts that suggest a higher dividend may be ahead.
Starting small to make a large nest egg
Clearly, investing £50 per week is unlikely to produce a large passive income in the short run. However, an investor who reinvests dividends could realistically obtain a large portfolio in the long run.
For example, investing £50 per week at the same rate of return as the FTSE 100 has managed in recent decades of 8% would produce an ISA portfolio valued at over £200,000 within 25 years. From this, a 5% yield equates to an annual income of £10,000. This could provide a useful supplement to the State Pension in older age, and lead to greater financial freedom in retirement.