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There are many passive income schemes out there. Many of them make outrageous promises, promising huge profits with almost no effort. But, if you dig deeper, most are out of reach for the average person.
They either require too much initial capital or simply take too long to generate a return.
So let's be realistic.
The painful truth is that “There is no such thing as a free lunch”Earning a significant passive income IS possible, but it won’t happen overnight and it’s unlikely to be in the millions.
What is considered “significant” depends on the individual. In my case, it would have to be at least £1,000 a month. That would require some time and investment, but it is a realistic amount for the average person.
How it is made
What could generate £12,000 a year (£1,000 a month) in passive income? You guessed it! Investing in the stock market!
To achieve that amount through investments you would need a return of 12% on £100,000 invested, or 8% on £150,000. I think somewhere in the middle of 10% is realistic – that's the average return on my current portfolio.
Okay, great. But who has £120,000 lying around? I don't.
That's where the time element comes in.
Saving that much money would take a long time. Fortunately, I have help. By making regular investments in dividend stocks and reinvesting the returns, I can increase my earnings and speed up the process.
An action to take into account
I like the prospects of a major global mining conglomerate. Rio Tinto (LSE:RIO). Over the past 20 years, it has risen by 322%, or 7.5% per year, on average. That is similar to the average annual return of the FTSE 100 Index.
What's not average is Rio's dividend yield. At 7%, it's double the average. London Stock Exchange Index (FTSE) An average of 3.5%. It doesn't take any complex math to figure out that 7% plus 7.5% results in significant gains.
On the downside, Rio Tinto has a history of scandals. Last year, it settled a $28 million fraud case involving the inflation of asset values at a Mozambique mine. This year, it faces scrutiny over pollution caused by a mine it operates in Papua New Guinea. From an ethical standpoint, this makes it a move that requires some consideration.
It is not clear exactly how much this affects returns. The price looks good at 10.5 times earnings with profit margins of 18.6% and debt at just 23% of equity. So it seems its biggest risk is potential fines or other costs related to damages or misconduct.
A diversified portfolio of several stocks can help reduce risk.
The path to passive income
There is no guarantee that growth will continue or that dividends will be paid, but let’s assume the above figures hold. A realistic initial investment of £10,000 combined with a monthly contribution of £200 could grow to £92,000 in just 10 years. After two more years, you would have over £120,000 and be earning a decent monthly passive income.
What if the portfolio underperformed, i.e. returned 5% per year with an average return of 6%? Even then, it would only take about 15 years to achieve a return of about £1,000 per month.
I think that's a realistic timeline and a realistic amount to aim for. Of course, the more time you invest, the better, so starting as early as possible is the best strategy.
