My strategy for building a passive income stream from stocks and shares is relatively straightforward. According to my calculations, by investing a small monthly lump sum of £200, I can build a substantial nest egg over the next few decades. And I can start drawing income from this pot whenever I need to.
Building a nest egg
To build a financial nest egg, I am concentrating on high growth stocks. An investment of £200 a month is not enough to generate a passive income immediately. That is why I am focusing on growth equities. Using this approach, I can grow my monthly investment substantially over the next decade or so, which should open the door to a higher level of passive income in the future.
Of course, this strategy may not be suitable for all investors. By investing in growth stocks, I can increase my chances of building a sizable financial nest egg, but it also increases the risk of losses. A meaningful loss could have a significant impact on my passive income ambitions.
Still, it is a strategy I am comfortable with, and to help reduce the risk, I would buy investment trusts and funds that focus on growth stocks.
Some examples of investment trusts that I think are attractive growth investments are the Mercantile Investment Trust and the JP Morgan Global Growth & Income Trust. Both of these investments companies focus on finding undervalued growth securities in both the UK and international markets. They also currently offer attractive dividend yields of around 3%.
The one downside of using this approach is the fact that these firms charge management fees, which could impact my returns. I also have no choice over the investments picked for their portfolios.
Over the past 10 years, these trusts have yielded an average annual total return for investors of 15%. Past performance should never be used to guide future potential, but I think these numbers provide some illustration of the sort of returns I could achieve by investing in growth stocks.
Passive income potential
Using a rough growth estimate of 12% per annum for the next 20 years, I calculate my £200 monthly investment could grow to be worth £200k within two decades. If I then switched from growth to income, targeting a 5% dividend yield on my investments, I think I could achieve an annual passive income of £10k or £830 a month.
It may even be possible to earn a higher monthly income by targeting higher yield investments. Indeed, some stocks in the FTSE 100, such as Phoenix Group, currently offer yields of more than 6%. A 6% return would suggest a passive income of £12k or £1k a month on a £200k investment pot.
This strategy is not perfect, and there is no guarantee it will yield an annual income of £10k after 20 years. There is also no guarantee the process will produce a £200k pot.
However, I think it has the potential to help me build a large financial nest egg and income stream over the next few decades.