The yearly limit on the Individual Savings Account (ISA) is more than enough for most investors. Even those who can’t max out their £20,000 limit have a good chance for a large passive income.
This is just as well. Only 7% of those holding a Stocks and Shares ISA and/or a Cash ISA use their annual allowance. With 2025 shaping up to be another tough year for Britons’ finances, the overall percentage is likely to remain pretty low.
The good news is that even those with just £5 to invest each day have a chance to build big passive income streams. Here’s how a modern investor might go about it today.
Falling savings rates
A fiver isn’t the largest amount to start off with. That equates to £1,825 a year. So that small amount needs to be invested intelligently to build a bulging bank account over time.
To maximise every penny, an investor may want to consider using a Stocks & Shares ISA over a Cash ISA. Today, the best-paying Cash ISA offers an interest rate below 5%. And the yearly return an individual can expect is likely to fall as inflation normalises and the Bank of England trims its benchmark rate.
Some analysts are tipping as many as four rate cuts this year alone, from current levels of 4.75%. This could have significant impact on peoples’ financial goals.
For the sake of this exercise, let’s use an interest rate of 4% and assume this remains stable for the next 25 years. That £5 saving invested regularly each day would eventually turn into £78,199.
Choosing shares
That’s not bad for a price of a coffee each day. But it’s not the kind of amount that’s going to deliver a decent passive income.
Based on an annual drawdown rate of 4%, that £78,199 would only provide a £3,128 yearly income before the well runs dry.
A more ambitious investor may wish to consider putting their money to work with shares, trusts or funds instead. While past performance isn’t always a reliable guide, an investment in FTSE 250 shares for instance could — based on the average yearly return of 9% since 2004 — become £172,523 over 25 years.
This would then create a healthy passive income of £6,821, based on that same 4% drawdown rate. That’s more than double what a Cash ISA could have provided. And those who leave their money to grow for longer could enjoy an even higher second income.
A top fund
Of course, the products typically bought in a Stocks and Shares ISA are riskier than holding money in a Cash ISA. So it may not be suitable for everyone.
But trusts and funds considerably reduce the risk investors face by diversifying across a selection of assets. Take the iShares FTSE 250 ETF (LSE:MIDD), for instance, which invests in hundreds of mid-cap UK shares.
With this product, an investor can target that 9% annual return while spreading risk across multiple sectors. Major holdings here include financial services provider IG Group, insurer Direct Line and luxury fashion house Burberry.
What’s more, the fund’s large cohort of multinational companies provides geographic diversification that reduces risk further.
This share-based fund may provide disappointing returns during economic downturns. But over the long haul, I’m optimistic it could help build a decent passive income for later on and is worth considering.
This post was originally published on Motley Fool
