I firmly believe that investing in stocks and shares is one of the best ways to create a passive income for life. Unlike other income strategies, buying equities does not require a large amount of upfront capital. Investors can get started with just a few pounds every month.
Thanks to the rise of low-cost online trading apps, equity markets have become a lot more accessible. Some passive income strategies require significant upfront investments. For example, to acquire a buy-to-let property, an investor might require an upfront investment of £100,000.
The same is not true with equity investing. I can go out and set up an investment plan to buy £25 worth of stocks every month and leave the market to take care of the rest.
That is why I am planning to create a passive income stream with an investment of £100 a month in stocks and shares.
Building the pot
This might not seem like a lot of money immediately, but it will really add up over time. An investment of £100 a month works out at £1,200 a year, or around £12,000 over the space of a decade.
That excludes any additional income received from the stocks and shares I acquire. I will be targeting companies with dividend yields between 5% and 9%. There are a handful of these opportunities on the market, although I should note that dividend income is never guaranteed.
As dividend income is paid out of company profits, if business profits suddenly decline, management may decide to cut the distribution. This is a risk I will have to consider when investing for passive income with equities.
Passive income portfolio
To help reduce the impact a significant dividend cut could have on my portfolio, I will be investing across a basket of dividend stocks.
For example, I would buy companies like the oil giant BP. This company currently supports a dividend yield of around 5%.
Outside of the oil and gas sector, I would also acquire the insurance group Direct Line. This stock supports a dividend yield of around 8%, at the time of writing.
I would also add the homebuilder Persimmon to the basket of companies. The stock supports a dividend yield of around 9% and has a strong track record of returning additional cash to investors when profits rise significantly. A basket of these three groups would produce a dividend yield of around 7.3% on my investment.
Based on this rate of return, I estimate I could generate £1,000 a year in passive income after 10 years of saving £100 a month.
That is assuming I can achieve an annual return of 7.3% on my money from dividends, which is not guaranteed. If any of the companies outlined decides to cut their payouts, my passive income stream could decline significantly.
Despite this risk, I would be happy to use this strategy to generate an income for life.
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Rupert Hargreaves owns Direct Line Insurance. 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.