My investing goal is to generate a passive income for my retirement. But how might I hit £10,000 per year? In a savings account, I’d need around a million at today’s low interest rates. And, well, that’s just not where millionaires park their cash.
No, it’s UK shares for me, mainly FTSE 100 stocks paying reliable dividends. So what kind of returns are they offering? The Footsie is forecast to pay close to 4% in dividends in 2022, which is a lot better than a savings account.
But some individual shares obviously offer more than the average. So I can do better than that.
Mining giant Rio Tinto is on a forecast 10% yield right now. And housebuilder Persimmon is expected to provide something similar. Those are both in cyclical sectors, though. And dividends are never guaranteed.
But by a careful spread of investments, and by having a significant portion of my money in the City of London Investment Trust (paying 4.7% now, having raised its dividend every year for 55 years), I think I can target passive income of 6% per year.
Long-term returns
The UK stock market has been returning a long-term average of 4.9% per year, above inflation. With inflation averaging around 2% per year long term, I think my 6% goal is realistic.
Even at that level, I’d still need to accumulate close to £170,000 to get my £10,000 in passive income. That’s a decent sum, but I reckon it can be achieved with relatively modest monthly investments. The secret is investing for the long term, and allowing compounding to weave its magic.
Here’s how it works…
Suppose I invest £250 per month in shares, and I hit my goal of 6% per year. Then I reinvest each year’s dividends in more shares, to generate yet more passive income in the following years.
That modest sum per month would get me a pot of approximately £41,000 after 10 years. But it gets better.
The magic of compounding
If I continue for another decade, after 20 years I’d have £114,000 in the pot. Wait! If I put in exactly twice the money, I get not far short of three times the amount out. That’s the extra returns from reinvesting my annual dividend income. And the longer I leave it, the better it gets.
Double the time again, to 40 years? This time, I end up with a cool £480,000 in the pot. Four times the investment will have netted me 10 times the final sum.
That amount would get me an annual passive income of close to £29,000 per year at that 6% per year. That’s nearly three times my target.
Passive income target
How else might I accumulate the £170,000 I need to achieve my passive income target of £10,000 per year? Well, I could do it in 17 years by investing £500 per month. Or just over 10 years at £1,000 per month.
These are just illustrative examples, and I can’t guarantee to achieve my aim of 6% returns per year. But I think it does show that building a healthy passive income for retirement is well within the reach of many of us.
And starting early makes all the difference. Over a long-term investing timescale, the early years count for the most.