Passive income schemes are a dime a dozen. Many of them make outrageous claims, promising huge returns with barely any effort. But when digging deeper, most are out of reach of the average person.
Either they require too much initial capital, or simply take too long to deliver a return.
So let’s get realistic.
The painful truth is, “there’s no such thing as a free lunch”. Earning a meaningful passive income IS possible but it won’t happen overnight, and it’s unlikely to be in the millions.
What constitutes ‘meaningful’ depends on the individual. For me, it would need to be at least £1,000 a month. That would still take some time and investment — but it’s a realistic amount for the average person.
How it’s done
So what could achieve £12,000 a year (£1,000 a month) in passive income? You guessed it — investing in the stock market!
To earn that much with investments would require something like a 12% return on £100,000 invested, or 8% on £150,000. I think a middle ground of 10% is realistic — that’s the average that my current portfolio returns.
Ok, great. But who has £120,000 just lying around? Not me.
That’s where the element of time comes in.
Saving up that much money would take ages. Fortunately, I have some help. By making regular investments into dividend shares and reinvesting the returns, I can compound the gains and speed up the process.
A stock to consider
I like the prospects of major global mining conglomerate Rio Tinto (LSE: RIO). Over the past 20 years, it’s up 322% — or 7.5% per year, on average. That’s similar to the average annual return of the FTSE 100.
What’s not average is Rio’s dividend yield. At 7%, it’s double the FTSE average of 3.5%. It doesn’t take complex maths to figure out that 7% plus 7.5% adds up to some serious gains.
On the downside, Rio Tinto has a history of scandals. Last year it settled a $28m fraud case related to inflating the value of assets in a Mozambiquan mine. This year, it’s facing scrutiny over contamination caused by a mine it operates in Papua New Guinea. Ethically, this makes it a stock that requires some consideration.
Exactly how much this affects returns is unclear. The price looks good at 10.5 times earnings with profit margins at 18.6% and debt at only 23% of equity. So it seems its biggest risk is potential fines or other costs involved with damages or misconduct.
A diversified portfolio of several stocks can help reduce risk.
The road to passive income
There’s no guarantee of continued growth or dividend payments but let’s assume the above figures are sustained. A realistic initial investment of £10,000 combined with a £200 monthly contribution could grow to £92,000 in just 10 years! After just two more years, I’d have over £120,000 and be earning a decent monthly passive income.
What if the portfolio underperformed, returning say 5% per year with a 6% average yield? It would still only take about 15 years to achieve a return of around £1,000 a month.
I think that’s both a realistic timeline and a realistic amount to aim for. Of course, the more time invested the better — so getting started as soon as possible is the best strategy!
This post was originally published on Motley Fool
