Saving for your future is so important and it does not have to mean making huge sacrifices if you start early. If you can invest £50 a week you’ll be putting just under £217 away each calendar month, which strikes me as a decent amount of money to invest throughout your working lifetime.
And going down the passive route has many attractions. To me, passive investing involves the absence of individual share picking and all the hard work that entails. And we can achieve a dividend income by investing regularly in passive, low-cost index tracker funds, which aim to track an individual share index or a particular sector of the market.
Compounding passive returns
Right now, the FTSE 100 index, for example, has a dividend yield of just over 4%. And if you pay money into an income version of a Footsie index tracker fund, you can collect regular passive dividend income from it.
If you are thinking of building up an investment that will be capable of paying you a regular passive income much later in life, perhaps when you retire, you can also do it with passive index tracker funds. Instead of selecting an income version of the tracker fund, you’ll need to select the accumulation version of the fund, which automatically rolls up the stream of dividends and ploughs them back into the fund for you.
And reinvesting the dividends like that will put you on the road to compounding your investment, which will likely turbo-charge it over time to deliver a much greater passive income later on.
The process of compounding works exponentially, which means that your absolute returns accelerate the longer you keep it up. So, if you do it for a working lifetime of around 40 years, you’ll likely end up with a handsome amount of money. When you want to draw on a passive income, perhaps to live on in retirement, you can switch the investment to an income version of a tracker fund. One following the FTSE 100 would be a reliable option.
Beyond the FTSE 100
But in the building stage, I’d explore beyond the FTSE 100. I see the FTSE 100 as good for harvesting and reinvesting dividends, but would also want some of my monthly investment to go into a mid-cap index tracker, such as one that follows the FTSE 250 index. I see that index as paying decent dividends from underlying companies that often also have plenty of potential to grow.
And I’d also want to participate in the American stock market because it is home to some of the world’s most dynamic and fastest-growing companies. So, I’d put a third of my monthly payment into a tracker that targets the S&P 500 index.
However, you can construct your own passive index tracker portfolio from the many options that are available these days and use your judgement about what sectors of the overall market are likely to perform well in the years ahead.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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 2019