What would £100 per month stashed in a savings account, paying a couple of percent per year in interest (if we’re lucky) get us in passive income?
Compound interest helps. Every year, we’d get interest on last year’s interest as well as on our original investment. That can add up. But when the interest rate is low, it’s not the stuff that millionaires are made of.
I only keep a small emergency amount of cash in a savings account. And my long-term investments have gone into buying shares in UK companies. So far, that’s wiped the floor with any savings account.
Isn’t it risky, though? Well, yes, it’s certainly riskier over the short term. And I’ve had years when my total investments have gone backwards. The last one was in 2020, when the pandemic gave the prices of my shares a good kicking.
Shares beat cash
But researchers at Barclays have been doing their homework. And they have the statistics to show that the longer our investing horizon, the greater our chance of coming out ahead with shares.
I don’t find it surprising, really. The FTSE 100 looks set to pay overall dividends of around 4.2% this year. And that includes shares that pay very little. So targeting annual dividend income of 5% or more has to be a plausible goal.
So what kind of long-term returns might I look forward to from shares? Firstly, I want to clarify that I’m not making any actual predictions here.
Dividends aren’t guaranteed, and they are often cut when a company doesn’t have enough cash one year. But spreading my funds across different dividend stocks in different sectors helps to lower that risk.
New record?
Many companies cut their dividends during the Covid pandemic, for example. But FTSE 100 dividends are already recovering strongly. And forecasts suggest 2022 could come very close to the all-time dividend record set in 2018. That year, FTSE 100 companies paid a total of £85.2bn in dividends. A bit of that could definitely help boost my passive income.
Suppose I put my £100 per month in a savings account and average 1.5% interest per year. That’s about where I’d expect long-term savings to go, once inflation drops back.
Over 30 years I’d invest a total of £36,000, and the compound interest would add around £9,400 to take me up to £45,400.
Shares instead
But what if I achieve 5% dividend returns from shares instead? Let’s add a modest 2% for share price appreciation, for a total annual return of 7%. That would add a whopping £81,600 to my invested cash for a total of £117,600.
That’s not a big enough lump sum to generate my targeted £10,000 per year in passive income from then onwards. But that’s starting with just £100 per month. Over the years, I’d gradually increase that whenever I could.
Again, there are no guarantees, and investing in shares carries risk. But I’m convinced of two things. The longer I invest, the lower the risk I’ll face. And I’m far more likely to generate a decent passive income from shares than a savings account.