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Building a passive income in the stock market isn’t hard. After all, the London Stock Exchange offers a vast array of dividend-paying businesses for investors to pick from, and even investing in a passive index fund can immediately start generating income returns. But how much money can investors earn with just £5,000 of starting capital?
Crunching the numbers
Let’s start by exploring the index fund approach. Right now, the FTSE 100 offers an overall dividend yield of 3.54%. So an investment of £5,000 at this rate would result in an annual passive income of £177.
Obviously, that’s not a life-changing amount. But let’s not forget that the total return of Britain’s flagship index is usually around 8% — or at least that’s what the long-term historical average gain has been. Assuming this continues, dividends can be reinvested to grow the portfolio and generate more passive income in the future. And if left to run for 20 years, the initial £5,000 would grow into £24,634, generating an income stream of £872.
This result could be easily doubled by throwing in an extra £50 each month over the investing timescale. With a steady stream of fresh capital, an 8%-yielding portfolio would reach £54,085, or £1,915 passive income.
But what if we want to take this even further? Instead of an index fund, investors can choose specific companies offering a far more substantial dividend yield than 3.54%. For example, Phoenix Group Holdings (LSE:PHNX) currently pays out 10.2% in dividends – the highest in the FTSE 100.
At this rate, a £5,000 initial investment generates £510 in annual passive income – 190% more than the FTSE 100. And if this portfolio is also left to run for 20 years, even with no capital gains, it would grow to £38,123 (£3,889 passive income), or £77,091 (£7,863 passive income) with a £50 monthly contribution.
Needless to say, it’s an enormous difference.
Nothing’s risk-free
The prospect of having up over 77 grand in the bank, earning just shy of £8k a year without having to lift a finger, is understandably exciting. But just like a FTSE 100 index fund, it’s dependent on Phoenix Group continuing to pay a dividend without its share price tumbling into oblivion. And that’s far from guaranteed.
In fact, a big reason why the company offers such a high payout is because there’s a lot of uncertainty circulating the insurance enterprise. The company’s in the middle of a strategic transition to become a more broad-based pension provider. And apart from complicating the financial statements, management’s lack of experience in this domain is calling into question whether this decision will prove successful.
So far, the company appears to be on track, beating its cash generation target of £1.4bn-£1.5bn in 2024, delivering an impressive £1.78bn. That’s good news for dividend investors and certainly suggests its 10.2% yield’s a bargain opportunity. But with fierce competition mounting, the question is can Phoenix maintain this momentum?
Personally, I’m cautiously optimistic, making Phoenix worthy of a closer look. Of course, a single stock doesn’t make a portfolio. And investors will have to search for other potentially lucrative opportunities to build a diversified passive income stream.
