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I’d follow these 3 steps to make a passive income of £25,000 a year from UK shares

Peter Stephens
·3-min read
A person holding onto a fan of twenty pound notes
A person holding onto a fan of twenty pound notes

While many UK shares have made strong gains in recent months, a number of companies continue to offer good value for money. Investing in them, and holding them, over the long run could produce a sizeable nest egg. From this a passive income can be drawn.

Furthermore, building a diverse portfolio and reinvesting dividends could be a means of reducing risk and increasing potential returns. Over time, this may produce a portfolio capable of sustaining an income significantly higher than the State Pension.

Investing in undervalued UK shares for the long run

At the moment many UK shares appear to be unpopular among investors. For example, sectors such as travel and leisure, consumer goods and financial services contain companies that trade on low valuations versus their historic levels. Such companies could deliver high returns relative to the wider stock market. Amd that could help an investor to obtain a larger passive income in the long run.

The track record of the stock market shows that buying undervalued shares and holding them through a stock market recovery can be a logical approach to capitalising on the ups and downs of equity markets.

Reinvesting dividends to make a passive income

Reinvesting dividends received from investments is a sound means of building a larger nest egg in the long run. Certainly, it is tempting to boost an income in the short run via dividends received. However, this could be detrimental to the level of passive income received in future.

The past performance of the stock market shows that a large proportion of its total returns have been generated by the reinvestment of dividends. Therefore, anyone who is aiming to obtain a generous income return in the long run may wish to sacrifice short-term spending where possible to build their portfolio value.

Diversifying to reduce risk

Another simple step to make a worthwhile passive income in the long term is to diversify among a range of companies and sectors. At the present time, the world economy is experiencing one of its most challenging periods for many years. Therefore, it is difficult to know which sectors will be beneficiaries of likely shifts in spending habits, and which ones will struggle to adapt.

As such, it is logical to own a mix of businesses in a portfolio. Over time, they could offer more resilient performance than a concentrated portfolio, as well as higher returns.

Generating a £25,000 passive income

Following the above three steps could help an investor to earn a generous passive income in the coming years.

The stock market has historically been a sound means through which to build a nest egg. For example, the FTSE 250 has produced 9% annual total returns in the past 20 years. By investing £350 per month at the same rate of return would produce a portfolio valued at £645,000 after 30 years. From this, a 4% annual withdrawal means an income of over £25,000 per year. This is more than double the current State Pension, and could lead to increased financial freedom in the long term.

The post I’d follow these 3 steps to make a passive income of £25,000 a year from UK shares 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 2021