I believe investing in stocks and shares is one of the most straightforward ways of generating a passive income. Here is the strategy I would use to generate a passive income with an investment of just £50 a week.
Passive income strategy
To make it clear, I am not saying I will be able to generate passive income immediately with just £50 a week. It will take time to build a pot large enough to generate a passive income.
For example, based on the market’s average dividend yield of around 3.8%, I estimate I will need to build a pot of £100,000 to generate a passive income of £3,800 a year.
To go about hitting this target, I would invest my money in dividend stocks. I think this will create a virtuous cycle whereby I will be able to reinvest the money earned from these investments and turbocharge the growth of my savings pot.
Some of my favourite passive income stocks on the market are Phoenix Group, British American Tobacco and Legal & General. At the time of writing, these companies support an average dividend yield of 6.6%.
Assuming this income level remains constant and these companies do not achieve capital growth, I estimated it would take 20 years of investing £50 a week into them to build a passive income pot worth £107,000.
Growth estimates
Of course, these are just estimates. I could invest more or less during this period. A small change in how much I put away could have a significant impact on returns, as could changes in the companies’ payouts.
Increasing my deposit to just £60 a week would enable me to hit the target within 18 years. On the other hand, if these companies cut their dividends by 50%, I estimate it would take me five years longer to build the £100k savings pot.
In this situation, I will have to revisit my passive income strategy.
There is always going to be a risk that the payouts will be reduced. Dividends are paid out of company profits. Therefore, if profits decline, the dividend may have to be cut.
Still, I think this strategy has a high chance of working. When I have hit my target, I can switch to taking income out rather than reinvesting.
In my example above, I noted that the average market dividend yield is 3.8%, which would yield an income of £3,800 on an investment of £100k. This is not set in stone. If I remain invested in the three blue-chip income stocks outlined above, I could boost my annual income to around £6,600. That would generate a passive income of £550 a month.
This strategy might not be suitable for all investors due to the risks involved with buying dividend shares. Nevertheless, I would use the approach outlined above to build a passive income stream from high-quality blue-chip equities over the next few years.
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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.
This post was originally published on Motley Fool
