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How to build passive income starting with just £20 a week

A senior group of friends enjoying rowing on the River Derwent
Image source: Getty Images

Building an impressive passive income stream is a financial goal shared by many. After all, who doesn’t like the idea of making money without having to put in any effort?

There are plenty of avenues to explore when aiming for this objective. Yet most require some substantial upfront funding that’s not always easy to come by. Luckily, investing in income stocks doesn’t suffer from this issue.

Obviously, an investment portfolio needs to be reasonably large to generate any meaningful income. However, investors can reach the required portfolio size over time by leveraging the power of consistent investing and compounding.

As such, even with as little as £20 a week, or £1,040 a year, it’s possible to get the ball rolling. Here’s how.

Building that passive income portfolio

The concept of investing in income stocks is pretty straightforward. Buy shares in high-quality enterprises that offer regular and sustainable payouts for the long term. But there are a few nuances to be aware of.

First off, investing isn’t free. While the cost of trading has dramatically dropped over the last few decades, buying and selling shares still incur transaction fees. Even with commission-free trading platforms, there are hidden fees that eat into capital.

Therefore, investing £20 at a time to build a passive income isn’t a sensible strategy since the more trades an investor executes, the more fees they have to pay. Instead, it’s wiser to build £20 each week into a small lump sum of around £260 and then use these savings to buy shares. That way, at the end of each year, the same amount of money is invested, but only four transactions take place, keeping trading costs much lower.

Why income stocks?

The financial markets are filled with plenty of income-bearing securities. And one of the most popular are bonds. As a quick reminder, a bond is a type of debt an investor can buy and receive interest payments. It’s a far safer investment than stocks, so why not use these instead?

For conservative investors, this may well be the better option. However, with reduced risk comes lower returns. With near-zero per cent interest rates over the last decade, bonds have struggled to even stay ahead of inflation. And while recent interest rate hikes have made bonds more attractive, they still pale in comparison to many top-notch income stocks.

How much can I make?

The FTSE 100 is home to some of the largest dividend-paying shares on the stock market. And, on average, the index has delivered a total average annual return of around 8%. Investing £260 a quarter into a low-cost index fund makes it possible to replicate this performance without difficulty. And after 40 years, a £20 weekly investment can turn into £300,545.

Obviously, four decades is a long time. But that’s nearly three times more than the £107,300 average retirement savings in the UK. And at an average 4% dividend yield, that’s enough to generate a passive income of £12,022 per year.

And when combined with the State Pension, an individual allocating just £20 per week could ensure they have a far more comfortable retirement than most.

The post How to build passive income starting with just £20 a week appeared first on The Motley Fool UK.

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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.

Motley Fool UK 2023