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The essence of investing for passive income is very simple. Put your money to work in high-quality investments. Withdraw when the target goal is reached. Whether the endpoint is £1,000, or £5,000, or £10,000 monthly passive income, the nuts and bolts are the same.
One difference between strategies comes in the savings rate. Those on smaller incomes who might be scratching around to save a few pounds a day shouldn’t be following the exact same process as those saving 10 times as much. Making bad choices in this regard could end up costing a lot of money in the long run.
Let’s compare two simple plans. First, a £3 a day saving rate, equal to about £90 a month. Second, a £30 a day saving rate, equal to about £900 a month.
Starting out
The first port of call is where to invest. If targeting the highest rates of returns on a historical basis, the best bet is to go for a Stocks and Shares ISA. The deposit limits on ISAs are £20,000 a year which accommodates both savings nicely. There’s no penalty for smaller amounts. Nice!
Where smaller savers need to be careful is fees. A transaction charge of £6 a trade is typical. That’s 7% of how much the £3 plan is saving each month, setting investors back before they’ve even started. One way to get around this is by investing less frequently. Another is to take advantage of commission-free ISAs like those offered by fintech Trading 212.
A second consideration for smaller investors is time. Saving £30 a day with 10% yearly returns reaches around £800k after 20 years. That’s the kind of money where we can withdraw a sizeable second income – all tax-free thanks to our ISA of course. But £3 a day will want a few extra years to get to the big money.
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.
Flexibility
Those saving bigger amounts also have more flexibility in diversifying a portfolio. Those saving smaller sums may wish to explore diversified stocks like index funds or investment funds.
Scottish Mortgagen Investment Trust (LSE: SMT) is one fund in which I have a position. This is a tech-heavy fund, intending to pick out the best and brightest in emerging technology firms. The fund bought Nvidia and Tesla before both stocks rocketed, for example.
Its concentration on technology stocks is a double-edged sword however. The share price has nearly doubled since 2023 along with a booming tech sector. But as fears of a ‘bubble’ grow, so do worries about the fund’s exposure to a collapse.
Another advantage is that the stock costs less than its equivalent assets. The technical term is ‘Net Asset Value’, which implies Scottish Mortgage is trading at about a 12% discount given its underlying holdings. Because many of the companies in the fund are unlisted though, this may be a sign that the market thinks the fund is overvaluing them.
All in all, whether it’s a £3, £30 or any other type of passive income plan, good stock-picking is at the heart of it. For that reason, I think Scottish Mortgage is worth bearing in mind.
