Right now, I don’t have the capacity to earn £2,000 a month in passive income. I wish I did, but it’s just not going to happen… yet.
It’s certainly possible in the future. And I can do this by compounding interest. This is the process of earning interest on my interest. And the longer I do it, the more I earn.
So, let’s take a look at how this might be possible.
The end goal
So, to earn £2,000 a month in dividends, I’d need around £450,000, earning a 5% dividend yield on average. At this moment in time, a 5% dividend yield is fairly easy to come across, especially when looking at UK-listed stocks.
Naturally, not all dividend payments would come at the same time. The £2,000 would be paid out throughout the year.
Getting to £450,000
So, here is the big question. How to I get to have a fund as big as £450,000? Well it’s going to take some time. But here are my calculations.
Let’s say I start with £50,000 and I invest my money in stocks offering a 5% yield on average. And instead of taking the dividends every year, I reinvest the payments I receive for 20 years. And on top of that, I invest £750 of my hard-earned cash every month in the pot too.
After 20 years, I’d have £443,000. That’s pretty close to the ‘goal’ figure I have above.
And after 20 years, maybe I’ll be looking to retire early, and £2,000 a month in passive income will certainly help. So, at this point, I could stop reinvesting my dividends and start withdrawing them to fund my life.
Sensible investments
The big question is where should I be putting my money? Right now, there are many companies offering sizeable dividends. But big dividends aren’t always sustainable. In fact, really big dividends certainly aren’t sustainable.
Instead, I need to make sensible investments. Therefore, I want to pick companies that I think are still going to be in business in 20 or 30 years.
So I’m not looking at companies selling cigarettes or even fast/unhealthy food. I know Greggs is a high street favourite, but I foresee there being a move towards healthier foods, and brands like Greggs could lose out.
So, for me, banks, insurers, wealth managers and housebuilders are a decent place to stay.
Legal & General is offering a whopping 6.9% yield right now. It’s a business that has a strong track record of paying dividends. It also has a strong brand reputation and is a cash generating machine. Both of these points give me confidence that it isn’t going away any time soon, and that it will continue to pay its shareholders.
Looking at banks, Lloyds is among those offering the best dividend yields. Currently the yield is 4.3%. Interest rates are rising, which should help the bank in the near term. And maybe this could mark a long-term move away from the last decade of historically low rates.