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Earning a passive income is one of the most satisfying financial goals an investor can set. The idea of money quietly building in the background without effort has long captured the imagination. And one of the simplest ways to make that dream a reality is through long-term investing in the stock market.
A Stocks and Shares ISA is one of the most efficient ways for UK residents to do just that. It allows investments to grow tax-free, meaning any dividends or capital gains stay entirely in the investor’s pocket. Over time, this can make a huge difference.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
A study by Barclays found that UK stocks generated average annual returns of almost 5% above inflation over a 119-year period. That’s a powerful figure — although, of course, returns are never guaranteed and in weak years, even the best portfolios can lose money.
Still, for long-term investors with discipline and patience, the rewards can be substantial. The key is knowing how to reduce risk and structure a portfolio to balance both growth and income.
Stock-picking for passive income
When aiming to build a reliable passive income, dividend stocks are often the first stop. They provide regular cash payouts that can either be reinvested or withdrawn as income. But focusing solely on dividends can be limiting.
Growth stocks — companies that reinvest their profits to expand their business — play a crucial role in building the initial pot of capital. Once that pot grows large enough, an investor can shift gradually into dividend-paying shares to generate consistent income.
Another important point is diversification. From consumer goods and healthcare to utilities and industrials, holding shares from different sectors spreads risk and protects against market shocks.
A FTSE 100 success story
The FTSE 100 is full of both dividend and growth opportunities. Rolls-Royce is one name that’s made a strong recovery since the pandemic, proving that patience often pays off. But for investors seeking a longer history of consistent expansion, Diploma (LSE: DPLM) is a stock worth considering.
Over the past 20 years, Diploma’s share price has climbed from 115p to 5,280p (as of 16 October) — an astonishing 4,491% increase. That works out to an annualised return of roughly 21% a year.
In simple terms, a £1,000 investment two decades ago would now be worth around £45,910. Few companies can boast such performance.
Of course, past performance is no guarantee of future results. Diploma’s success stems from its disciplined strategy of acquiring and growing niche industrial businesses across engineering, life sciences and controls.
Revenue has grown at a compound annual rate of 20% since the pandemic, and earnings are up 44% year on year. It’s a well-managed, profitable company with a strong balance sheet.
That said, no business is without risks. Diploma’s reliance on acquisitions exposes it to integration challenges and potential overpayment for assets. A slowdown in global manufacturing or supply chain disruption could also weigh on margins.
Final thoughts
Building a strong passive income takes patience, diversification and consistency. Growth stocks like Diploma can help build wealth over time, while dividend stocks add stability and cash flow.
The FTSE 100 offers plenty such opportunities for investors. With thoughtful planning — and ideally the tax relief of a Stocks and Shares ISA — an investor can aim to create lasting passive income.
