My strategy for building a passive income stream from stocks and shares is relatively straightforward. According to my calculations, by investing a small monthly lump sum of £200, I can build a substantial nest egg over the next few decades. And I can start drawing income from this pot whenever I need to.
Building a nest egg
To build a financial nest egg, I am concentrating on high growth stocks. An investment of £200 a month is not enough to generate a passive income immediately. That is why I am focusing on growth equities. Using this approach, I can grow my monthly investment substantially over the next decade or so, which should open the door to a higher level of passive income in the future.
Of course, this strategy may not be suitable for all investors. By investing in growth stocks, I can increase my chances of building a sizable financial nest egg, but it also increases the risk of losses. A meaningful loss could have a significant impact on my passive income ambitions.
Still, it is a strategy I am comfortable with, and to help reduce the risk, I would buy investment trusts and funds that focus on growth stocks.
Some examples of investment trusts that I think are attractive growth investments are the Mercantile Investment Trust and the JP Morgan Global Growth & Income Trust. Both of these investments companies focus on finding undervalued growth securities in both the UK and international markets. They also currently offer attractive dividend yields of around 3%.
The one downside of using this approach is the fact that these firms charge management fees, which could impact my returns. I also have no choice over the investments picked for their portfolios.
Over the past 10 years, these trusts have yielded an average annual total return for investors of 15%. Past performance should never be used to guide future potential, but I think these numbers provide some illustration of the sort of returns I could achieve by investing in growth stocks.
Passive income potential
Using a rough growth estimate of 12% per annum for the next 20 years, I calculate my £200 monthly investment could grow to be worth £200k within two decades. If I then switched from growth to income, targeting a 5% dividend yield on my investments, I think I could achieve an annual passive income of £10k or £830 a month.
It may even be possible to earn a higher monthly income by targeting higher yield investments. Indeed, some stocks in the FTSE 100, such as Phoenix Group, currently offer yields of more than 6%. A 6% return would suggest a passive income of £12k or £1k a month on a £200k investment pot.
This strategy is not perfect, and there is no guarantee it will yield an annual income of £10k after 20 years. There is also no guarantee the process will produce a £200k pot.
However, I think it has the potential to help me build a large financial nest egg and income stream over the next few decades.
Rupert Hargreaves owns shares in the Mercantile Investment Trust and the JP Morgan Global Growth & Income Trust. The Motley Fool UK has no position in any of the shares mentioned. 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.
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