2 simple steps to earning £400 in monthly passive income

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There are many ways to go about generating a passive income stream. Some try starting a business, or investing in real estate, both of which have been proven successful strategies over time. The problem is they require a lot of work, let alone the initial capital requirements.

What if there was an easier way? When used correctly, the stock market is arguably one of the greatest wealth-building devices available to everyone.

That doesn’t mean it’s risk-free, far from it. But by investing in high-quality dividend shares, it’s possible to start seeing the money flowing in within a few weeks.

How? Let’s go through the four primary steps.

1. Save money to build a passive income

Let’s start with the basics. To buy shares, I need money. The question is, how much? Since I’m aiming for £400 a month, my portfolio needs to generate £4,800 per year. And I also only want this passive income to originate from dividends since I don’t want to sell parts of my portfolio to hit this annual target.

Looking at the FTSE 100 index, the average dividend yield throughout the last couple of decades has hovered around 4%. But by picking individual dividend shares instead of lobbing my money into an index, boosting the yield to 5% shouldn’t be too much trouble.

But this is where most people get stuck. Generating £4,800 from a 5% dividend yield means I need a portfolio worth £96,000! Needless to say, that’s not exactly pocket change. And I doubt I could get a bank loan. Fortunately, I don’t have to.

2. Discover the power of compounding

Before reaping the rewards of my passive income stream, I first have to build it. And thanks to a little trick called compounding, hitting £96,000 is a lot easier than most would think.

Instead of trying to save up the capital and then buy shares in one go, I’m going to invest a small amount consistently over time. Let’s say I can comfortably spare £100 from my monthly salary for investments. Assuming my portfolio can match the 11% average performance of the FTSE 250 index, I would hit my target in about 20 years.

Increasing my monthly contributions would drastically reduce the waiting time. However, it’s critical to only invest money I don’t need for at least the next five years. Why? Because the stock market can be a volatile place, as 2022 has so perfectly demonstrated.

In the short term, stock prices can move quite drastically, especially with a portfolio in growth mode. And I can say with a high degree of certainty another correction, or even a crash, is likely within the next two decades. Depending on the timing of these events, hitting my milestone could take significantly longer than anticipated. That’s why investing to meet short-term financial obligations is a terrible idea, I feel.

While the thought of suffering through a market crash doesn’t sound fun, it’s essential to put things in perspective. When I buy shares, I’m buying a piece of a business. And if the business succeeds, then so will my investment.

Therefore, by investing exclusively in high-quality companies, I can be comfortable knowing that when the stock market has another tantrum, my stocks will likely recover before growing even higher in the long term.

The post 2 simple steps to earning £400 in monthly passive income appeared first on The Motley Fool UK.

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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.