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I am sure it is possible to generate a passive income stream by investing in quality stocks.
Let me explain how I would do this if I had money to spare.
Rules of the game
First things first, I need an investment vehicle. My preferred method would be a stocks and shares ISA. With this, I have an annual allowance of £20,000. Furthermore, the advantage of this choice is that I do not have to pay a single cent of taxes on the dividends received.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
I then decided to invest £250 a month, for 25 years. By carefully selecting the stocks that pay the best dividends, I will use my money to buy stocks with the possibility of maximizing my pot.
My goal would be to buy about 10 stocks and diversify my holdings, which I think will increase my chances of achieving my goal.
Next, if I aim for a 7% rate of return, after 25 years I would be left with a total of £203,949. The next thing I have to do is withdraw 5% to enjoy it. Withdrawing 5% would leave me with £10,197 a year.
This is a nice sum that I can enjoy during my retirement to whatever my heart desires. It is worth mentioning that at this stage I will also have other investments and pensions to increase my income. Plus, I'll have paid off my mortgage by then, so that will be a major expense that I won't have to worry about.
As a caveat, I understand that dividends are never guaranteed. Furthermore, I could aim for 7%, but my shares could yield less. On the contrary, they may even pay more and I could be left with a larger pot than I intended.
banking giant
An example of the type of actions that will help me achieve the above plan is HSBC (LSE: HSBA).
Even though the economic woes of the last year hurt banking stocks, HSBC stock is rising. The shares are up 17% in a 12-month period from 586p this time last year to current levels of 687p.
I believe the potential of the China-focused bank is incalculable, especially from a growth perspective. As the region's level of wealth grows rapidly, HSBC has the existing presence and brand power to capitalize on. Higher performance could boost investor returns.
Currently, a dividend yield of over 7% is attractive. Plus, the stock looks like excellent value to me right now with a price-to-earnings ratio of just eight.
The biggest risk that could derail HSBC's performance and returns is twofold. First, continuing economic problems around the world could hurt growth ambitions. A prime example of this is the economic slowdown in China in recent months.
Next, potential future geopolitical tensions between superpowers China and the United States could also hurt growth in the region. In turn, this could also affect HSBC's performance. I will be watching closely on both fronts.
Overall, I think a stock like HSBC would be a big help in helping me build my second income.
