How I’m using £120 a month to aim for £12,500 a year in passive income!

Mixed-race female couple enjoying themselves on a walk

Dividend stocks providing me with passive income form a considerable part of my portfolio. However, I’m fortunate in that I don’t need this passive income right now. Instead, I reinvest my dividend payments to generate wealth in the long run.

This allows me to benefit from something called compound interest. This is essentially the process of earning interest on my interest. And the longer I leave it, the more I earn.

So, let’s take a look at how I could turn £120 a month into £12,500 a year.

Compound returns

Compounding returns does not guarantee success, but I contend that it carries less risk than investing in growth stocks.

I’m actually still a fairly long way from retirement, so I’m going to be investing for the next 40 years.

If I were to start with £10,000 and put away £120 every month for the next 40 years, and invest and reinvest in dividend stocks with 5% yields, at the end of four decades, I’d have a whopping £250,000.

And with £250,000 invested in stocks paying a 5% yield, I can expect to earn an impressive £12,500 a year in dividend payments. That’s a pretty handy return given I would have been investing less than £1,500 a year.

But the longer I leave it, the more money I’ll have. Having said that, I’ll be getting fairly old in 40 years, so maybe it’s best I don’t leave it too long!

It’s also worth noting that the more money I put in now, the more I’ll have in the future. It sounds obvious but compound interest has the capacity to make my investments multiply.

Sensible stock choices

Investing for the long run can be tricky, after all none of us know exactly what the market is going to look like in 20, 30, or 40 years’ time.

However, there are a few things that I’m fairly sure of. The first is that tobacco companies aren’t going to be selling tobacco anymore, at least not in the UK, and that means these firms will have to complete their transition towards smoking alternatives. This might not be so profitable.

I’m also concerned about investing in things like fast food stocks. I see there being increasing need to encourage healthy lifestyles, particularly in the West, where we have a growing ageing population.

Dividend yields change as payments vary and share prices go up and down, but I’m looking at solid UK value stocks, such as Lloyds, HSBC and Barratt Developments.

These three stocks provide decent yields, averaging around 5%. I’m also confident that banks and housing developers are still going to be operating in the years to come.

I’d also look at healthcare giants such as GSK, which is down right now due to lawsuits in the US. However, it’s unlikely that this issue will put GSK out of business.

The post How I’m using £120 a month to aim for £12,500 a year in passive income! appeared first on The Motley Fool UK.

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James Fox owns shares in Lloyds, GSK, HSBC and Barrett Developments. The Motley Fool UK has recommended GSK plc, HSBC Holdings, and Lloyds Banking Group. 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.