Earning a passive income is arguably one of the most delightful financial experiences. After all, who doesn’t love the idea of money magically materialising in the bank regularly without having to lift a finger for it?
There are lots of different ways to establish a second income stream. But investing, while it involves some risk, probably requires the least effort. And investors also don’t need much capital to get started.
Of course, trying to replace an entire salary won’t happen overnight. In the UK, the average annual income is around £25,971, according to the latest Office for National Statistics figures. Assuming an investor can match the FTSE 100’s average dividend yield of 4%, they’d need a portfolio worth roughly £650,000 to achieve this.
Obviously, that’s not pocket change. But by leveraging the power of compounding returns, putting aside as little as £5 a day can build this six-figure portfolio given sufficient time. Here’s how.
Keep saving consistently
The first and most crucial step to building a £650k portfolio has more to do with financial discipline than investing itself.
Saving £5 a day can be achieved relatively easily. Even for households strapped for cash, skipping a morning coffee, making a packed lunch, or cancelling an unused subscription can help secure this capital. The challenge is doing this consistently every day, all year round.
Temptations are everywhere, whether it be a service station pitstop on a long drive or going to the pub with friends. And while it may not seem like a big deal at the time, in the long run, skipping just one day of saving can have a massive negative impact on passive income generation.
The stock market has historically delivered an average return of 10%. At this rate, £5 compounded over 35 years translates into £163.20. In other words, skipping just one day of saving will cost an investor over £160 in the long run!
Building a passive income portfolio
Saving £5 a day equates to £1,825 a year for investing, or roughly £152.08 per month. It may be tempting to immediately focus on investing in FTSE 100 shares. After all, the index does contain the largest enterprises on the London Stock Exchange, providing a yield of 3% to 4% each year. What’s more, it’s also significantly less volatile than other UK indexes.
However, these advantages come with the drawback of lower returns. On average, the FTSE 100 as a whole has delivered annual returns of around 8%. That’s certainly nothing to scoff at. But investors comfortable with a bit more risk may want to consider selecting individual companies to build a growth portfolio before transitioning to passive income once enough capital has been built up.
Stock picking is a challenging endeavour that requires dedication and discipline. If executed poorly, an investor can easily destroy wealth rather than create it. But it also paves the way for market-beating returns. Even if these returns amount to just an extra 2%, that can significantly cut the time required to build a £650k investment portfolio.
At a 10% return, investing £152.08 each month will transform into £639,957 within 36 years. And while that does assume there are no hiccups along the way, such a portfolio could unlock a far superior retirement lifestyle.
