Passive income can be described as earnings from an investment in which a person isn’t actively involved. So drawing a passive income in retirement would be great.
One way of achieving it is to invest in shares and share-backed vehicles such as funds. In my opinion, that’s perhaps the best way, rather than investing in property or other assets, for example.
Building a passive income
But to gain a significant passive income, we must first build up our invested money. And putting away £25 each week would be a good place to begin. I’d choose a Stocks and Shares ISA wrapper to shelter my investments from tax and begin paying the money in.
Perhaps the most convenient way is to pay it in monthly amounts as soon as your wages hit your bank current account. So I’d begin with a monthly transfer of around £110 into my ISA account.
One of the great things about aiming for around £110 per month is that many share funds will allow you to immediately start investing. Often the minimum regular investing limit is around £25 with low costs, so your £110 would be well over that bottom limit. And within your ISA wrapper, you can often arrange automatic monthly investments into managed funds and tracker funds, for example.
And in the beginning, I reckon it’s a good idea to invest in funds because your money will be spread over many underlying shares giving you plenty of diversification. However, you need your investments to be working hard for you while you’re in the building stage. So it’s a good idea to choose the accumulation version of the funds you invest in. That’s because they automatically roll your dividend income back into your investment, helping you to compound your gains. And that will help you build your investment pot of money.
Seeking higher returns from shares
As your investments grow in value and if you can invest more each month as well, you may become interested in investing in the shares of individual companies. Many investors end up doing that in the pursuit of higher returns. However, to me it only makes sense if you can invest at least £1,000 in each share in one go, otherwise the transaction costs could be too high.
However, your stocks and shares ISA will still be the best home for your investments. And if funds build up in your account, you can invest them in shares you’ve researched and reinvest your dividends along the way. Such constant reinvestment is the kind of strategy that made successful ISA investors rich like Lord John Lee – he was the first in Britain to declare himself an ISA millionaire!
After years of compounding your gains, you can switch to drawing passive income from your investments, perhaps in retirement. To do that, you can switch your funds from accumulation to the income version where the dividends are paid to your bank account rather than being rolled back in. Or you can stop reinvesting dividends from individual companies and draw the dividend income from your ISA. Good luck on your passive income journey!
Kevin Godbold has no position in any share 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.