Passive income from stock
Posted: Feb 13, 2019
Building a passive income can be a lot easier than most people think if you start early and remain patient. The power of compound interest makes it possible to build a passive income without being rich. Without having a large income.
Let's pretend that you currently earn USD 50 000 a year and you want to be able to keep collecting USD 50 000 after you stopped working and are living off your passive income from dividends. It is possible to build a dividend portfolio that pays you a 5% yearly dividend. If you want to collect USD50 000 a year you need to have USD 1 000 000 invested in stocks. It might seem impossible to invest USD 1 000 000 in stock when you only earn USD 50 000 a year. You would have to save every dime you earn for 20 years to be able to invest USD 1 000 000. That is not possible because you need to eat, to live. If you deposit half your pay each month it would take 40 years to save USD 1 000 000. 40 years during which you have to live very poor because you save so much,
However, I did not say you have to invest USD 1 000 000 to be able to earn USD 50 000 each year from dividends. I said that you have to have USD 1 000 000 invested. That is something very different. You do not have to invest 1 000 000 to have 1 000 000 invested.
Let's pretend that you invest USD50 000 in stock. This is a lot more achievable. You can save 10% of your paycheck during 10 years to invest USD 50 000. We assume that you have invested your money in high-quality stock and that you get a 12.5% yearly return on your stock (the historical average). We will also assume that you reinvest your 5% dividend in new stock each year. If you do this, then you will have USD 1 258 135 invested after 20 years. You have reached your goal of having USD 1 000 000 invested even though you only invested 50 000. If you reinvest all returns for another 5 years you will have over 2.8 million invested and will get almost 150 000 from dividends each year. The power of time and compound interest allow you to build a large stock portfolio without having to invest a lot of money.
There are a few things you should think about to be able to achieve these results:
Fees are your enemy. All fees you pay will have a large impact on your financial status in 20 years. Especially yearly fees based on portfolio size should be avoided like the plague as they reduce the power of the compound interest. You should choose a broker with as low fees as possible. I personal use e-trade. E-trade has low fees and a long history of good customer service. You can read more about e-trade here. Robinhood is another alternative. They offer free trading but I personally prefer a broker with a large selection of stocks to trade with.
Warning: RobinHood offers some services that are more like gambling than investing. Read more here.
Chose blue-chip stock
Avoid high-risk investments and only invest in premium stock. Your goal is to earn a steady return at low risk. Not to try to get rich quick and risk losing all the money in the process. The slow and steady approach is a lot more likely to succeed and is how most wealthy people have built their portfolios.
Invest long term
Only invest in companies that you think are a good long term investment. Your goal should be to never sell a stock once you bought it. It is impossible to know the future. You might have to sell a stock due to changing market conditions but your goal should always be to buy stocks you can keep forever. You will have to pay a fee every time you buy or sell a stock and fees are as we already determined to be avoided. Another reason that you should try to invest long term is that we want the stock portfolio to require very little to no supervision. It should manage itself most of the time.
Finance professional who likes writing about finance and pets.