The passive income strategy I’d use with £5 a day

I firmly believe that investing in stocks and shares is one of the best ways to generate a passive income. Indeed, this is the approach I use. 

What’s more, thanks to the rise of low-cost and free trading apps, it is now possible to start investing in stocks and shares with sums as small as £35 a week, or £5 a day. 

As such, here is the approach I would use to generate a passive income with such a small outlay.

The path to passive income 

However, a deposit of £5 a day will not be enough to immediately generate a large passive income stream. But it will help me build the foundations of an income portfolio. 

I would start by investing this money in a portfolio of growth stocks. There are a couple of ways to do this. My preferred strategy is to buy a growth fund like the Scottish Mortgage Investment Trust.

Using this strategy, I can build a portfolio of growth stocks at the click of a button, managed by experienced growth investors. As picking stocks can be a risky and time-consuming business, I think this strategy makes more sense for a smaller portfolio. 

The aim of this strategy is simple. I want to grow my funds as fast as possible to allow me to switch to income generation. For example, let’s say I can earn a return of 15% per annum (Scottish Mortgage has returned 30% per annum since 2016) on my £5 weekly investment.

At this rate, I could build a pot worth £33k in 20 years. If I switch from growth to income, I estimate I could generate an annual passive income of £2k from this portfolio. This target assumes I can acquire stocks with an average yield of 6%. Some examples of the sorts of income investments I would buy include British American Tobacco and Phoenix Group.  

Navigating challenges 

There are some significant risks and challenges to using this approach. For a start, it is impossible to tell what the future holds for the stock market over the next 20 years. Past performance should never be used to guide future potential, so basing potential returns on past performance is not sensible. 

Further, there is no guarantee British American and Phoenix will still offer yields of 6% in 2041. 

One way to speed up the growth of the pot could be to invest more. If I double my weekly deposit to £44, I could build a pot worth £34k within 16 years. If I keep saving this amount for two decades, the nest egg could grow to be worth £66k, potentially producing a passive income of around £4k a year. 

That is the strategy I would use to generate a passive income from stocks and shares with a deposit of just £5 a week. 

Rupert Hargreaves owns shares of British American Tobacco. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.