Creating passive income is very attainable with focus and consistency. Mathematically speaking, even with a small starting sum, a decent, growing passive income can be created. And over time it can snowball because of compounding – when dividends are reinvested to create more income year after year.
Passive income and compounding
There are four main factors at play when it comes to creating a portfolio of investments that will then pay out income. There’s the starting amount, the monthly contribution, the returns percentage, and time. All are important. It’s easier though to control the monthly contribution and amount of time invested than it is to create a bigger starting amount or increase investment returns. So I’d focus on these.
Really the main thing is to get started as soon as possible because time in the market is a critical component to allow compounding. It’s why Warren Buffett has made so much of his wealth in recent years. The snowball he started rolling many years ago has gathered pace and got bigger and bigger. This is the power of compounding.
My route to creating £1,000 a month passively
To create £1,000 in an average month I calculate that I’d need an investment portfolio equating to around £300,000. If there’s an average yield of 4%, then that’s £12,000 per year. This is realistic given the FTSE 100 dividend yield average is only a little below 4%, with many shares yielding in excess of 5%. However, bear in mind dividends are not guaranteed and companies do sometimes cut dividends.
Nonetheless, getting to this amount of money is achievable. If I start with nothing but add £500 a month and earn a return of 8% (so dividends and share price growth combined, known as total return) then it’ll take 23 years to get to £300,000. Upping the contribution to £650 per month but keeping everything else the same would bring it down to under 20 years. Of course, these variables are not guaranteed and can change as the illustrations prove.
So my route to generating passive income is to invest every month. I’ll invest in UK shares to try and earn a total return at or above 8% a year.
Particularly to make the investing passive, I’ll focus on higher yielding, high-quality shares. Examples of shares meeting this criterion, in my opinion, are Persimmon, Polar Capital, and CMC Markets. I think the current market sell-off has also created some opportunities for buying great companies at cheaper prices. That includes the three companies just mentioned, which are all on reasonable valuations, but also some AIM-listed companies. Boohoo, GB Group, and Numis are all examples fitting this category.
The crux of my plan to create £1,000 a month passively is to invest in UK shares. The present market volatility potentially creates opportunities for long-term investors and I intend to buy more shares over the coming weeks. This will help me to create passive income for the future and build my investment portfolio up to a value of £300,000, or hopefully even more.