Fifteen grand a year in passive income isn’t going to allow me to retire, but it’s enough to make life easier.
Here, I’ll explore how £20k invested in shares could lead me to a £1,250-a-month passive income stream.
Choosing the right vehicle
To start, I’m always going to invest in my Stocks and Shares ISA. This account allows me to invest in a wide selection of shares, investment trusts, and exchange-traded funds.
It also enables my portfolio to grow free from the grubby mitts of the taxman, as any capital gains or dividends earned within my ISA are not subject to tax. For me, it’s an absolute no-brainer!
Of course, shares don’t always go up and dividends aren’t certain to be paid. So diversification is very important to minimise risk.
Personally, I reckon £20k invested evenly in 10 shares provides a solid foundation and adequate level of diversification. Any more would start to spread my investments too thinly, diluting potential gains.
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.
Choosing my shares
Many investors choose to buy blue-chip UK dividend shares to aim for passive income straight away. Due to the high yields around right now, I think it’s entirely realistic to build a quality income portfolio that yields 7%.
However, this isn’t going to get me anywhere close to £1,250 a month. To aim for this, I prefer to build a portfolio with more long-term growth potential, then switch fully to dividends and passive income later on.
Potential hedge fund bargain
One unique FTSE 100 stock that I own in my ISA and think has great long-term growth potential is Pershing Square Holdings (LSE: PSH).
This is an investment trust that gives me exposure to the hedge fund of renowned Wall Street investor Bill Ackman. He looks for firms with competitive advantages, strong management teams, and scalable operations.
Hedge funds are normally limited to the well-heeled, so this is a pretty rare stock. Ackman has returned 22% annually over the last five years, which easily beats the S&P 500‘s 16%.
That’s no mean feat, and it’s propelled Pershing Square stock 155% higher in five years!
Ackman specialises in investing in time-tested brands that have fallen on hard times. For example, he invested in Chipotle Mexican Grill in 2016 after an E. coli outbreak, generating fantastic long-term returns.
Recently, he bought shares of Nike after the share price bombed due to weak consumer spending and mounting competition.
One risk here though is Ackman himself (key person risk). If he lost his touch or wasn’t able to carry on for some reason, the hedge fund’s value would be jeopardised. I could lose money on my investment.
Still, the shares have fallen 15% since June and are now trading at a 36% discount to the fund’s underlying net asset value. This suggests that the stock may be significantly undervalued, which is why I’m keen to add to my holding the next time I have cash available.
Enjoying income
With stocks like this, I think it’s realistic for me to aim for an average 10% return over time, reinvesting dividends along the way to compound my returns.
Here’s how that would play out.
| Year | Accrued interest | Balance |
|---|---|---|
| 1 | £2,000 | £22,000 |
| 5 | £12,210 | £32,210 |
| 10 | £31,874 | £51,874 |
| 15 | £63,544 | £83,544 |
| 25 | £196,694 | £216,694 |
Once I reach £216k, I’ll have the option to switch to a 7%-yielding dividend portfolio. This would provide me with annual passive income of £15,168 — or just over £1,250 a month.
This post was originally published on Motley Fool
