Making a life-changing passive income is one of the ultimate goals of any investor. Who wouldn’t want to earn a sustainable flow of money with little or no effort?
To some, it seems like an impossible dream. But in practice, anyone with a commitment to regular investing has a chance to make a substantial second income over time.
Here’s how I’d try to make a passive income above £23k by investing just a couple of hundred pounds each month.
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Axe tax
The first thing I’d do is open a tax-efficient investment product. In the UK, we’re predominantly talking about the Individual Savings Account (ISA) and the Self-Invested Personal Pension (SIPP).
With both of these financial products, I have a chance to invest in a wide range of different assets. We’re talking about stocks, bonds, funds and trusts, for instance. Alternatively I can just hold my money in cash.
The beauty is that I don’t have to pay a penny to the taxman on capital gains, dividends, or interest. Over the long term, this can add up to a fat stack of cash.
Official forecasts suggest ISA holders saved £6.7bn in tax in just the 2023/24 financial year.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Build a diverse portfolio
Next, I’d prioritise investing in equities using a Stocks and Shares ISA, due to the superior returns I can expect. I’ll talk more about this in the next section.
Investing in stocks involves me taking on more risk than, say, parking my money in cash. But that’s okay. I can still comfortably manage risk by purchasing a wide range of equities across different industries.
I’d also buy some exchange-traded funds (ETFs) to reduce my risk. This could give me exposure to hundreds of companies at a stroke, while also investing my money in other areas like the bond market.
Finally, I’d hold a small percentage of my money in a Cash ISA, for easy access to capital and for risk purposes.
Target the FTSE 100 and FTSE 250
With the majority of my cash earmarked for shares, I’d focus more specifically on buying FTSE 100 and FTSE 250 shares. In recent decades, these indexes have provided a terrific average annual return of 9.3%.
Gold producers Centamin (LSE:CEY) is one such company I’d buy in my Stocks and Shares ISA. This is one of the London Stock Exchange‘s biggest mining operators, with a flagship mine in Egypt and several exploration assets elsewhere in Africa.
There’s risk here, as commodity prices can be volatile. But I think this is reflected in Centamin’s low valuation. It trades on a price-to-earnings (P/E) ratio of just 8.6 times.
In fact, now could be a good time to invest in gold shares given current price action. The yellow metal is up 13% since the start of 2024, and keeps hitting regular record highs above $2,400 an ounce.
Past performance isn’t always a reliable guide of future returns. But if that 9.3% long-term average for the FTSE 100 and FTSE 250 continues, a £200 monthly investment in shares like this could net me £584,781 after 30 years.
This would then give me a yearly passive income of £23,390, assuming I drew down 4% of my pot each year.
