When considering how I can make passive income from the stock market, there are two main avenues. The first is to use dividends as a stream of cash that I can benefit from later in life. Or I can invest in growth stocks for capital appreciation and then withdraw portions of it in years to come. If I mix the two together, I think it’s possible to make the average UK salary (£31.4k) in passive income.
Setting everything up
I’m going to assume that my time horizon is 25 years, at which point I want to be able to start enjoying the income and drawing down on my portfolio. In the period until then, I’m happy to simply put cash away regularly and invest it.
I accept that this isn’t a perfect investment set-up. Over the next few decades, it’s plausible that I won’t be able to keep up the monthly investment amounts. This could be for a variety of reasons. Further, my assumed investment returns might also be wrong. Yet when planning this far in advance, I’m going to have to make at least a few assumptions like this. At least it’s a strategy that I think is realistic.
With that out of the way, I can crack on. I’m going to target £550 a month, half of which will go into dividend stocks, with the other half going into growth stocks. I’m aiming for an average dividend yield of 6% for the income side, with a growth rate of 8% for the other shares. Based on historical data and current yields, I think this is reasonable.
Forecasting the passive income potential
At the end of 25 years, I could have a pot worth £448,600 if my assumptions are correct. The following year, I can take out the dividend income and also take out some cash by trimming profits from my growth stocks. In theory, this annual amount should come to 7% of my total pot, £31,402.
As my stocks should hopefully continue to grow in value, with the dividends also being paid each year, I can enjoy this amount of cash each year. As I made clear earlier, these assumptions could under/overstate the actual figures. This depends on the market cycle, dividend payments and other elements. But if everything goes as planned, I could realistically be able to draw this level of income in my retirement.
How can I reduce some of the risks involved? A key way is to invest in a broad range of stocks with my £550 each month. This way, I can diversify my exposure away from a certain sector or a particular geography. Over time, I should be able to build enough of a range so that if one stock has a poor year, it shouldn’t impact my overall performance materially.