Passive income has a powerful appeal. Who wouldn’t want to earn extra cash for minimal effort? I certainly would!
Well, it’s possible to target a passive income stream from dividend stocks that could potentially last a lifetime. I reckon this can be done by investing just £200 a month.
Here’s how.
Buying my future freedom
Finding £200 to invest each month isn’t easy, but it’s worth it.
I automate my investing. By moving money into a Stocks and Shares ISA at the beginning of the month, I’m not tempted to spend it.
Thanks to the power of compound returns, spare cash I put in the stock market today could be worth much more as time passes by.
Securing passive income for life
So, how much passive income could I earn by following this plan?
A lot depends on my portfolio’s compound annual growth rate (CAGR). For context, the FTSE 100 index has historically returned around 6%-8% annually over long periods.
There’s no guarantee that the UK stock market will continue to deliver these returns in the future. That risk should be borne in mind. Nonetheless, it’s a good benchmark to use for forecasting purposes.
Of course, it’s possible to secure higher gains. A well-chosen mix of stocks could beat the market.
To illustrate these variables, let’s forecast three potential eventualities that could arise from investing £200 per month over a 30-year time horizon.
I’m assuming I could secure an average 5% dividend yield across my shares, which should be achievable with some smart picks. That said, dividends are never guaranteed and companies can cut or suspend payouts during tough times.
Crunching the numbers
If I underperformed the FTSE 100, the numbers could look like this.
| CAGR | Final portfolio size | Annual passive income |
|---|---|---|
| 5% | £163,772 | £8,189 |
If my portfolio matched the index’s historic average, the figures are as follows.
| CAGR | Final portfolio size | Annual passive income |
|---|---|---|
| 7% | £235,302 | £11,765 |
Finally, this is what might happen if I outperformed the Footsie.
| CAGR | Final portfolio size | Annual passive income |
|---|---|---|
| 9% | £343,086 | £17,154 |
Even marginal improvements in my portfolio’s CAGR could produce dramatically different passive income streams when the time comes to spend my dividend payments.
A dividend stock to consider
To aim for the maximum amount of passive income, I’ll need to invest in high-quality dividend stocks. One that’s worth considering is mining giant Rio Tinto (LSE:RIO).
The company’s policy is to pay a dividend ranging between 40% and 60% of its earnings. Granted, the commodities industry is highly cyclical. Investors should expect fluctuations in their passive income payouts.
But, the group’s dominance in the global iron ore market due to its Western Australian operations can’t be overstated. The steelmaking metal accounted for 73% of the company’s first-half underlying operating profit.
Rio Tinto’s also the largest investor in the Simandou project in Guinea — one of the world’s largest untapped reserves of high-grade iron ore. This should cement Rio Tinto’s market-leading position for years to come.
Weak demand from China is an ongoing risk amid a construction slump in the world’s second-largest economy. It’s worth monitoring developments on this front.
Nevertheless, at a forward price-to-earnings (P/E) ratio of 8.4, I think Rio Tinto’s valuation looks attractive today.
This post was originally published on Motley Fool
