Seeking a passive income from the stock market is arguably one of the most popular financial goals. After all, who doesn’t love the idea of making money without having to lift a finger?
Leveraging an ISA also takes income taxes out of the equation, and given enough time, even a modest monthly investment can eventually transform into a six-figure salary. With that in mind, let’s explore how big a portfolio needs to be to unlock a £100,000 tax-free passive income.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Let’s do some number crunching
In the world of personal finance, it’s often recommended to follow the 4% rule when withdrawing capital from a portfolio. The logic is to enable a nest egg to continue growing even though an investor is taking out funds. Using this rule, if an investor wants to earn a £100,000 second income, they’d need a portfolio worth £2.5m.
That’s obviously not pocket change. What if we stretch the rules a bit and withdraw 5% per year? In that case, the goal would be to build a £2m portfolio. Taking half a million off the target is nice, but that still leaves investors with the challenge of becoming a multi-millionaire.
Fortunately, when investing for the long term, this objective is more achievable than most would think. Setting aside £500 each month and investing it at 8% — the average return of the UK stock market – would translate into a £2m portfolio in approximately 42 years.
That certainly sets someone up for a nice retirement. But 42 years is obviously a long time to wait. So, how can investors accelerate the wealth-building process without putting in more capital each month?
Stock picking provides an answer
Instead of relying on a passive index fund, investors can take control of their portfolios and pick individual stocks to buy and hold. Is it riskier? Yes. But when executed well, stock picking can deliver game-changing results.
Take Ashtead Group (LSE:AHT) as a prime example. Today, it’s one of the largest equipment rental businesses in the UK, US, and Canada. But 30 years ago, the group was just a small business that noticed the significant benefits equipment rental had over ownership.
Investors who bought into Ashtead’s vision and held on have subsequently reaped an average 15.5% annualised return. And at this rate, the journey to £2m doesn’t take 42 years, but rather 26.
Today, jumping on the Ashtead bandwagon may still yield impressive results. The equipment rental market continues to grow, and management’s latest expansion into Canada opens up a whole new front of opportunity. However, double-digit annualised gains might be a tall order for an £18bn company. Don’t forget it’s not a small-cap nowadays.
There are also operational risks to consider. Higher interest rates have caused a significant slowdown in the construction sector in its core US market. And the group is hardly short on competition, with its chief rival, United Rentals, fighting to stay on top.
Regardless, this demonstrates that through stock picking, while the risks and volatility are higher, smart investors can potentially earn exceptional returns, unlocking exceptional passive income.
This post was originally published on Motley Fool
