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How I’d build a £5,000 monthly passive income by investing in shares

Young female hand showing five fingers.
Young female hand showing five fingers.

With the stock market seemingly in freefall this year, investing in shares to build a passive income may seem like madness to some.

There are undoubtedly companies facing the heat of macroeconomic factors. Yet many have sufficient resources at their disposal to weather the storm. And when the stock market eventually recovers, as it has done in every previous correction or crash, these businesses can once again resume their growth and value-generating trajectories.

In other words, buying today while prices are cheap could send my portfolio through the roof in the next couple of years. And even accelerate its journey towards millionaire territory.

Let’s explore how I can leverage today’s stock market environment to eventually make £5,000 appear in my bank account each month.

Building a four-digit monthly passive income

The prospect of sitting on a sunny beach with a mojito and watching the money roll in without having to lift a finger sounds delightful. But there are a few steps that need to be taken before arriving at this destination.

A passive income through the stock market typically comes in the form of dividends. And, on average, dividend-paying stocks offer a yield of around 4%. Several high-quality companies are offering more. So a carefully selected portfolio could realistically generate a 5% yield without compromising reliability.

However, this quickly highlights a financial barrier. At a 5% yield, my portfolio would need to be worth £1.2m to generate my desired £5,000 monthly passive income. And that’s not exactly pocket change. Fortunately, building such a large portfolio in the long run isn’t as impossible as many think.

The FTSE 250 is down a horrendous 28% so far this year. But, historically, the index has actually delivered returns of around 11.3% annually after dividends. Assuming this performance can continue, sparing just £500 from my monthly salary for investing would enable me to build a £1.2m in around 28 years, if I were starting from scratch today.

Understanding the risk

Waiting nearly three decades to hit my passive income goal is obviously frustrating. And I may end up having to wait even longer.

After all, there is no guarantee the FTSE 250 will resume its historical rate of return once the current stock market correction is over. And even if my average return drops by just one percent, it could add years to the waiting time.

Of course, the opposite is also true. With so many top-notch UK shares trading at dirt-cheap discounts, my average return could increase, potentially reducing the waiting time by several years.

In other words, the future performance of my portfolio is shrouded in uncertainty. And it’s only exacerbated by the high likelihood of multiple stock market crashes and corrections in the future.

Depending on the timing of these events, my passive income portfolio could see enormous chunks of value wiped out that could take years to recover from. This is especially true if a once-thriving business in my portfolio is brought low because of an external force. Just look at what happened to travel stocks in 2020.

But even with this in mind, earning a prospective £5,000 a month makes for a lovely retirement plan, in my opinion. That’s why I believe it’s a worthwhile endeavour, especially with the stock market offering such a low entry point today.

The post How I’d build a £5,000 monthly passive income by investing in 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 2022