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One of my favourite ways to target future passive income is by investing in shares. More specifically, investors can make use of tax wrappers like a Stocks and Shares ISA, or SIPP, to achieve future income.
Within these, it’s possible to own a range of managed funds, exchanged-traded funds (ETFs), or individual shares.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Targeting £1,000 of monthly passive income
If an investor wanted to target a £1,000 monthly income, that equates to £12,000 a year. A commonly used withdrawal rate of 4% means that this investor would need a pot worth £300,000.
That might sound like a chunky sum to save, but when broken down over many years, it’s far more manageable.
For instance, I calculate that a 40-year-old would just need to invest £500 a month over 20 years to build such a pot. Some eagle-eyed readers might note that this just adds up to a total investment of £120,000.
That’s because I’d expect the remaining £180,000 to appear from investment gains over time. The assumption here is that it grows by 8% a year. And given long-term investment returns have been around 8%-10%, I think that’s a reasonable assumption to make.
Of course, by targeting greater returns (and accepting greater risk), an investor could reach their goal far quicker. One way that I aim to do that is by selecting individual shares and holding them for many years.
Rewards from long-term investing
One such FTSE 100 share that I’ve owned for several years is Games Workshop (LSE:GAW). Its share price has soared by over 1,200% since I first bought it back in 2017.
If an investor had spent £500 a month on just this share since then, they’d be sitting on a pot worth over £210,000 already. That’s a phenomenal achievement in just eight years. It would also likely result in a much earlier passive income than planned.
But there are a few things to bear in mind. First, I would never suggest that anyone invest everything in one stock! Second, Games Workshop wasn’t large enough to be in the FTSE 100 back in 2017. It was a much smaller business.
Smaller companies can often grow much faster than giant, mature businesses. As UK small-cap investor Jim Slater famously quipped, “elephants can’t gallop”.
It also traded at a much lower price to earnings ratio. Today, it hovers around 30, but back in 2017 it traded as low as 10 times earnings. It’s not as cheap as it used to be.
Still a great business
Looking ahead, I still consider Games Workshop to be a high-quality business with ample potential. It operates in a niche market that is difficult to replicate. That gives it a competitive advantage.
In turn, it earns a chunky double-digit profit margin and an incredible 70% return on capital employed.
In recent years it has partnered with Amazon to bring some of its vast character universe to movies and TV shows. And this licencing revenue has much more room to grow in my opinion.
A long-term investor could consider this and similar prospects. And although much can go wrong with individual shares, by selecting a diversified group of 10-20 names, it would spread the risk.
