Earning passive income is an ambition shared by investors all across the globe. After all, it can significantly enhance financial freedom and stability.
The goal is to receive a consistent stream of money without requiring constant effort. And this can be achieved by investing in income-paying stocks that distribute dividends to shareholders.
But just how much would I need to invest to secure a reliable passive income of, say, £250 a month?
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Achieving a high average yield
The honest answer is that it all depends. To be a little more precise, it depends on the average annual yield I could achieve on my investment portfolio. So, for the purposes of illustration, let’s assume I’ve built a portfolio comprising a diversified basket of income-paying stocks.
If I could achieve an average 4% yield, then to bring in roughly £250 a month of dividend income I’d need a portfolio worth around £75,000. However, if I netted an average 8% yield (about the same as the FTSE 100‘s average total annual gain), I’d only require a portfolio in the region of £37,500.
Perhaps something more realistic would be for me to target a 6% average yield. In this case I’d be aiming for a portfolio worth £50,000. Amassing such wealth might seem daunting at first glance, but it’s far more achievable than most people might think.
Building an investment portfolio
By investing relatively small sums of cash into a selection of high-quality shares, I could comfortably reach this milestone even after starting out with nothing.
The key would be to initially reinvest all my dividends to benefit from the power of compound returns. This is the process that enables a modest sum to be turned into a substantial fortune over time.
For example, if I invested £500 each month and achieved a 6% annualised return, I’d have a pot worth around £53,000 after nine years. At this point, I could stop reinvesting dividends and instead start taking them as income.
Navigating the challenges and uncertainty
While that all sounds straightforward, it’s important for me to note that investing to build a passive income stream doesn’t come without challenges and risks.
Above all, stock market volatility and economic downturns consistently threaten to impact my future ability to generate passive income. For instance, amid harsh business conditions, companies can cut or suspend shareholder payouts to preserve cash.
Emotional decision-making in response to such scenarios increases the likelihood of impulsive decisions. These often to go on to affect an investor’s portfolio in a harmful way. For example, emotional trading that focuses only on the short term could result in me panic-selling a stock during a downturn. In so doing, I’d likely miss out on the potential recovery in the long run.
Accordingly, to mitigate these risks and maximise my chances of earning a reliable passive income, I’d take a long-term view with an investment horizon that spans decades. That way, I’ll be well-positioned to ride out the near-term fluctuations in the stock market.
