Is there anything better than earning a passive income stream? I do not think so. An income stream that requires little to no effort to maintain itself can help you reach your financial goals without extra effort.
However, it can be difficult to generate a passive income stream.
Some of the most popular assets for passive income, such as property, require a substantial initial investment that most investors simply do not have.
But you don’t have to be wealthy to generate passive income. It is possible to derive passive income from the stock market with an investment of only £ 5,000.
Passive income strategy
The best way to earn such stock market income is to buy investment trusts.
Investment trusts are ideal for investing in dividends because they can store excess income in the right times for a rainy day.
This quality has become particularly desirable recently. While companies have cut their dividends in recent weeks, investment trusts have taken hold.
And after the recent declines, some of the major market investment trusts are now supporting single-digit dividend yields.
For example, Aberdeen Standard Equity Income currently supports a dividend yield of 9%. the Edinburgh Investment Trust gives 6%, and Murray International Trust gives 5.6%. A portfolio made up of these three trusts would yield just under 7% per year.
So, if this is passive income you are looking for, it is definitely worth considering these trusts for your investment portfolio.
Indeed, an investment of £ 5,000 in these three trusts would yield a total annual income of £ 350. This may not seem like much at first, but these trusts have a reputation for increasing their dividends based on long-term inflation. On top of that, by reinvesting income, investors can overeat their returns.
Reinvest for returns
My figures show that an investment of £ 5,000 in these three trusts would be worth £ 10,000 after a decade assuming that all income is reinvested and that dividends increase in line with inflation. A pot of £ 10,000 would be enough to produce just under £ 700 of passive income per year.
This is an example of a base case. In reality, these trusts should also experience long-term capital growth. However, since capital growth cannot be predicted, I leave this part of the equation for simplicity.
The figures become even more attractive if an additional £ 5,000 is added each year.
After a decade of saving £ 5,000 a year and reinvesting a 7% dividend yield, the pot could be worth up to £ 91,000. This would be enough to generate an annual income of £ 6,000.
So you don’t have to be a millionaire to generate a passive income stream. Any investor can start their journey today with an initial investment of just £ 5,000. By reinvesting the dividends received, this initial investment could develop to become a significant financial nest egg in the long term.
It’s ugly there …
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Rupert Hargreaves has no position on any of the actions mentioned. The Motley Fool UK does not hold any positions in any of the stocks mentioned. The opinions expressed on the companies mentioned in this article are those of the author and may therefore differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. At The Motley Fool, we believe that taking into account a diverse range of ideas makes us better investors.