How much passive income can you potentially earn by investing £500 a month?

Investing in the stock market is a fantastic way to build a passive income, especially since, in 2025, it doesn’t take that much money to get the ball rolling.

Perhaps one of the most widely discussed strategies is finding and buying shares which pay chunky dividends. And with UK stocks having some of the most generous dividend policies in the world, it’s easy to see why this approach is so popular.

But realistically, how much money can investors expect to make with only £500 a month to work with? Let’s explore.

Setting expectations

On average, the most mature and established large-cap stocks in Britain have offered a dividend yield of around 4%, while also delivering another 4% in capital gains. This translates into an 8% total return. And investing from scratch with £500 a month at this rate for 30 years, on paper, produces a £750,000 portfolio.

Assuming the yield’s still the same 4%, that’s a passive income of £30,000 a year. And while market volatility may cause this to be higher or lower than expected, it’s a reasonable expectation when working on a time horizon of three decades.

But what if investors exclusively focus on the stocks which offer more than 4% in annual dividends? What about a company like Legal & General (LSE:LGEN) with its massive 8.3% yield? Well, if it still produces a 4% annual capital gain, not only would the previous portfolio grow to a whopping £1.8m, but the yearly passive income would reach £155,000!

Too good to be true?

There’s no denying that the prospect of potentially earning over a 150 grand without having to lift a finger is exciting. But let’s be smart and look at the risks as well as the potential rewards. An 8.3% yield’s pretty substantial. Yet it can actually be a warning sign to stay away since this level of payout’s exceptionally difficult to maintain.

In the case of Legal & General, there are a variety of justifiable concerns surrounding this business. The higher interest rate environment has certainly worked wonders in boosting the firm’s revenue and earnings. Yet the company’s still paying out more in dividends than it’s actually bringing in when looking at the payout ratio.

Needless to say, that’s not sustainable in the long run. Even more so if the company starts writing badly-priced insurance policies. Don’t forget, as a life insurance business, the firm’s issued policies can last for decades. And the consequence for misjudging future payouts can be enormous over time.

Having said that, management’s attempting to improve the coverage situation through structural simplification, merging some divisions while disposing of non-core ones. While interest rates have started to tick down, the bulk purchase annuity market remains strong, giving the group a nice tailwind to piggyback. And if everything goes according to plan, not only would dividend coverage improve, but payouts could rise as well.

The bottom line

Overall, Legal & General shares present a lucrative dividend opportunity for investors willing to take on considerable financial and macroeconomic risk to consider. As things stand, the risk’s too high for my tastes. But the good news is there are plenty of other high-yield opportunities for investors to explore on their journey to building a chunky passive income.

The post How much passive income can you potentially earn by investing £500 a month? appeared first on The Motley Fool UK.

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Zaven Boyrazian has no position in any of the shares mentioned. 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.