Generating passive income from stocks isn’t too difficult at first. But getting to the mighty sum of £50,000 in annual passive income is going to take time and patience. That’s why a SIPP (Self-Invested Personal Pension) is arguably the ideal vehicle to achieve this long-term goal.
That’s because unless I’m 55 (or 57 from 2028), I can’t dip into my SIPP and sell shares to raise cash. And this helps us follow investor Charlie Munger’s first rule of compounding: never interrupt it unnecessarily.
Here are three easy steps that I’d follow to get to £50k in annual passive income.
Invest like clockwork
The best way to grow my wealth in a SIPP is to make regular investments. I’m a stock market investor, so the vast majority of my DIY pension is invested in shares of different companies. And I’m split more or less evenly between US and UK-listed stocks.
The reason I invest in shares is because of the numbers. They have outperformed all other asset classes (bonds, cash, etc.) over the very long term.
Now, that doesn’t mean stock market investing is necessarily easier. Quite the opposite, in fact. The market can be extremely volatile at times, with share prices fluctuating in head-scratching ways. Some companies may even go bust (Cineworld being a recent example of this).
Yet, over many decades, UK and US stocks combined have still managed to deliver an average annual return of 7%-10%. Therefore, stock markets are battle-hardened, having shrugged off numerous wars, recessions, financial crises, and now a serious worldwide pandemic.
Of course, none of this guarantees that shares will return the same over the next couple of decades. But in the grand theatre of wealth-building, I think shares will continue to steal the show.
Quality at a reasonable price
Instead of filling my SIPP with speculative punts, I’d plump for high-quality companies that have enduring business models and sustainable competitive advantages.
One example would be Ferrari (NYSE: RACE), which is arguably the most powerful luxury brand on earth. Its customers are the uber-wealthy, so are largely insulated from cost-of-living pressures. And the firm maintains an aura of exclusivity by always making one car less than the market demands. This gives it almost unlimited pricing power and fat profit margins.
However, identifying great businesses is only one part of investing. The other is assessing whether the shares of a company I like are trading at what I consider to be a reasonable valuation.
In the case of Ferrari, the stock is currently trading on a P/E ratio of 49. That’s a premium valuation that could present risk if markets head south or the firm’s growth suddenly decelerates. Long term though, I’m bullish.
Passive income from dividends
So, let’s assume I invest £100 a week for 30 years in my SIPP. How much could I end up with? Well, assuming I manage an average 8.5% annual return (in the mid-point of the historical average), then I’d finish up with about £837,818.
If I were then to switch my focus to dividend-paying shares returning 6% per year, then I’d expect to be generating just over £50k in annual passive income.
Better still, as things stand, I can claim tax relief on my SIPP contributions. Investing that extra money would significantly increase my final amount.
