I firmly believe that buying stocks and shares is a great way to earn a passive income. Indeed, compared to other strategies, it is relatively straightforward to start generating income with equities.
Most people turn to buy-to-let property when looking for passive income streams. However, with the average UK property price now sitting at around £260,000, and the average buy-to-let mortgage provider requiring a deposit of at least 40%, I would need a lump sum of £104,000 to pursue this strategy.
By comparison, I can start building a passive income portfolio today with just £25. Thanks to the rise of free trading apps, I do not even have to worry about paying commission.
And using this approach, I think I can earn a passive income with a lump sum investment of £200 a month.
Investing for growth
However, investing this sum a month will not be enough to produce a substantial income stream overnight. That is why I plan to start by targeting growth stocks. By using this approach, I hope to be able to grow my savings over the next decade, or so. When I have reached a predetermined figure, I can then switch from growth to income.
The predetermined figure I have set out is £50,000. If I hit this target and invest this money in stocks yielding 8%, I can earn a return of £4,000 a year. That works out as £330 a month. This would be enough to cover roughly half of my housing costs, freeing up additional capital for me to save into my investment account.
Assuming I can earn a 10% return on my investment every year, I believe I can hit this target within 11 years. Of course, there is no guarantee I will be able to earn this return. Equity markets can be incredibly volatile, and in an economic recession, stocks could slump in value. This would derail my strategy.
Nevertheless, I believe that by focusing on high-quality growth stocks, such as Apple and Microsoft, I can improve my chances of hitting this target.
Investing for passive income
When I have hit my capital target, I can switch to investing for income. There are a couple of stocks on the market right now which offer dividend yields of around 8%. These include British American Tobacco and Persimmon. Some companies even provide double-digit dividend yields. Rio Tinto, for example, could yield approximately 16% this year.
I would buy a basket of these companies for my portfolio. By acquiring a diversified portfolio of income stocks, I think I can increase my chances of hitting my 8% per annum yield target. After all, as dividends are paid out of corporate profits, the distributions are not guaranteed. There is always going to be a chance these businesses will cut their payouts.
Still, even after taking these risks into account, I believe the above approach can help me hit my passive income target with an investment of just £200 a month.