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Dividends paid by publicly listed companies (stocks) is the best, and arguably most predictable, way of earnings a passive income. And unlike with real estate investments, we can start building a diverse portfolio of stock investments with a relatively small amount of cash.
Unfortunately, £2,000 in savings isn’t going to generate much passive income today — at most, we could achieve £180 in the first year. However, there’s a simple and well-trodden path for turning our savings into a mega portfolio capable of generating life-changing passive income.
The recipe for success
Starting with £2,000 in savings, here’s how an investor can grow their money into a bigger portfolio that generates passive income:
- Invest regularly: adding money to our investments every month, even if it’s just a small amount, helps our money grow faster.
- Use compound interest: reinvesting any earnings (like dividends) back into the portfolio. This means we earn returns on our returns, which can really boost growth over time — honestly it’s the secret sauce to portfolio growth.
- Diversify: spreading money across different types of investments, like stocks, ETFs, and bonds helps reduce risk.
- Be patient: building wealth takes time. Stick to the plan and don’t panic during volatility.
- Consider dividend-paying stocks: as our portfolios grow, we can invest in stocks that pay regular dividends. This can provide a steady stream of passive income.
This really works
It might sound simple, but it really works. However, success is, of course, dependent on us picking the right investments. If we make poor investment decisions we could lose money.
But to make this less hypothetical, let me tell you what happens when we make the right investment decisions. A little over a year ago, I opened a Junior ISA. I made monthly contributions and invested in a range of stocks. Fourteen months later, the valued of the investments is up 61% and the portfolio is now worth five figures.
Now, annualised returns of around 50% are hard to achieve. I would say it’s impossible but I do know of portfolios that have achieved growth like this over the long run — J Mintzmyer’s for example.
In the below table I’ve shown how our £2,000 starting pot could grow, assuming £250 of monthly contributions.
| 8% | 16% | 43% (J Mintzmyer) | |
| 10 years | £50,175.79 | £82,944.52 | £606,650.68 |
| 20 years | £157,108.71 | £479,648.85 | £41,939,034.76 |
| 30 years | £394,461.32 | £2,423,873.33 | £2,867,315,789.27 |
Now, most novice investors will be aiming for high-single digit returns. But it all depends on the quality of those investments. And just a note on J Mintzmyer — even he would struggle to keep up that rate of return over 30 years.
Keeping it simple
I like to focus on quantitive data, only investing in companies that meet the threshold, like Twilio (NYSE:TWLO). The company trades with a price-to-earnings-to-growth (PEG) ratio of one, and has very strong profitability grades.
The communications firm is on the up following rounds of efficiency drives that have turned this perennial underperformer into a darling of the stock market. It’s also got momentum, with the firm up 66% over the past 12 months.
However, with a price-to-earnings ratio of 30 times, there’s not much room for error. Nonetheless, I think it’s worth considering. It has an excellent track record of beating earnings estimates and I think the stock could go much higher.
