There are many ideas out there for earning long-term passive income.
A Stocks and Shares ISA has always been my chosen approach, with the UK stock market having beaten other forms of investment for more than a century.
UK investors took out more than 12m new ISAs in the 2022/23 year, the most recently reported. Most were Cash ISAs though, which seems like a missed opportunity to me.
Ten grand
Over the past 10 years, the average Stocks and Shares ISA annual return has come in at 9.6%. On that basis, we’d need to build up a pot of about £105,000 to get us to our desired £10k per year in income. But a look at the UK’s ISA millionaires suggests we could aim a lot higher.
There are close to 5,000 of them in Britain now. They mainly got there buying shares and reinvesting their dividend cash. And they took an average of 22 years to reach a million. An investor aged 45 today could still have 22 years of investing ahead of them before they reach UK state pension age.
The 9.6% per year has perhaps been unusually high, with annual FTSE 100 returns averaging 6.9% over the past 20 years. But that’s still very respectable. So how might we try to emulate it?
Follow the index
Let’s look at the the iShares Core FTSE 100 ETF (LSE: ISF). It’s an exchange-traded fund that just tries to track the return of the FTSE 100. And it does that by aiming to hold some of each stock in proportion to its index weighting.
And just like that, with a single investment we can have our cash in some of the best companies the UK has ever known.
It gets us a stake in AstraZeneca, HSBC Holdings, Shell, Unilever, and RELX as the five biggest UK companies. It includes M&G, which hash the FTSE 100’s biggest forecast dividend yield at 10%. And National Grid is there too, with a more modest 5.2% yield but a great track record of annual dividend rises.
A tracker fund like this still shares the risks of the stock market in general. But if it can match that 6.9% annual average for the FTSE 100, what might it get us? An investor who can use the whole £20,000 ISA allowance each year could reach a million in 22 years — just like the average ISA millionaire.
Aiming higher
I mentioned the 10% dividend expected from M&G — so how might that boost our ISA? A 10% return per year reinvested could grow above the magic million mark in 19 years.
We must remember that a dividend is never guaranteed, and I really don’t expect we’ll see that yield every year. And M&G can be volatile too, so there’s share price risk.
But I think it hints at a possible strategy. Consider starting out by following the FTSE 100 with a tracker fund. And then maybe branch out to seek bigger returns with portions of our cash in subsequent years
