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Invest in shares of companies listed on the Stock Exchange FTSE 100 It has proven to be an ideal way to start generating passive income. Over time, this can eventually give me a second income of £10,000 or more.
It is true that it is more difficult to save money to invest these days due to the rising cost of living. And winter is coming and our houses need heating, which certainly isn’t cheap these days.
But if I want to generate a substantial stream of passive income, I’ll have to put my money to work somewhere. Here’s how you would do it by creating a portfolio of high-quality Footsie stocks.
Spending less than I earn
Unfortunately, the concept of living frugally sometimes gets a bad rap. This is because it is often confused with living a Spartan existence without comforts.
But in my opinion, it simply means living within my means. I can still enjoy occasional luxuries.
More specifically, however, it means spending less than I earn in order to build up a monthly savings amount, whether £500, £1,000 or more.
For me, I think an amount between those two figures (say £750) is realistic and could be a useful milestone to aim for.
Saving £750 each month would mean being able to invest £9,000 annually.
Picking solid FTSE 100 stocks
There are plenty of high-quality FTSE 100 stocks I can choose from today. But I would start with world-class companies that have a long history of increasing their dividends and underlying value.
A good example here would be BAE Systems (LSE: BA.). As the world unfortunately becomes more unstable due to multiple wars, governments are increasing their military budgets. And many are increasingly turning to large defense contractors like BAE.
The company’s order book stood at a record £66.2bn at the end of June. That was before the Middle East erupted into conflict again.
While BAE has increased its dividend payout for decades, it currently only yields 2.5%.
However, it is important to remember that this is an initial dividend yield. If the company can continue to grow its earnings and payouts, then the return relative to what I paid for my shares could grow from 2.5% to 3%, then 3.5%, then 4%, and so on.
Additionally, I would invest in some high-yield dividend stocks to create a diversified portfolio. This is crucial to minimize the impact of unexpected dividend cuts and share price declines.
BAE shares could fall if, for example, investors begin to worry that the high level of military spending is not sustainable.
How quickly could you reach £10,000 in passive income??
Now, let’s say I invested £750 a month in FTSE 100 shares, reinvested my dividends and achieved an average return of 7% a year. That return is not guaranteed, of course, but it is the rough long-term average for the Footsie.
In this scenario, due to the power of compounding, my portfolio would be worth around £146,600 after 11 years.
If I then switched entirely to dividend stocks that collectively yielded 7%, I would have reached my passive income target of £10,500 a year. However, the same diversification principle would still apply: my portfolio would be invested in a wide range of companies to reduce the chance of underperformance.
