Enjoying a growing income without having to work for it is likely to be a goal for many people. While it may sound like an unrealistic aim in the short run, over the long term it could be achievable through regularly investing in the stock market.
Over time, this could build a surprisingly large nest egg from which a passive income can be drawn. By investing in companies that exhibit reliable financial performance and solid dividend growth, it may be possible to make a robust passive income each year that ultimately replaces your wage.
Building your portfolio
Most people who are aiming to replace their salary with a passive income are unlikely to have sufficient capital to do so today. Therefore, building a portfolio of stocks could be a good idea. It will have the potential to produce relatively high annual returns that, over the long run, can provide a sizeable nest egg.
For example, indexes such the S&P 500 and FTSE 100 have historically offered high-single digit annualised returns. Although there will inevitably be periods where their returns are disappointing due to economic challenges and weak investor confidence, over the long run they appear likely to offer capital growth that is in line with their historic averages.
Therefore, focusing your capital on a diverse range of shares and allowing compounding to positively impact your portfolio valuation could be a worthwhile move. Moreover, with the stock market currently facing an uncertain outlook as a result of significant political and economic risks being present across a number of regions, it may be possible to purchase high-quality stocks at attractive prices. This may produce above-average returns for investors over the coming years.
Generating a passive income
While it may take time to build a portfolio which is large enough to produce a passive income that fully replaces your wage, the stock market’s track record of growth suggests doing so is entirely possible for a large proportion of investors.
In addition, generating a passive income that grows at an above-inflation pace and which is reliable is an achievable goal. Through investing in a wide range of businesses that are relatively uncorrelated to one another, such as occupying different geographical regions and operating in a range of industries, it may be possible to mitigate many of the ongoing risks which face investors. This could provide a more robust passive income that increases year-on-year.
Furthermore, by investing in companies that have a strong track record of dividend growth due to them having a competitive advantage within their industry, your passive income may be relatively resilient to economic risks. As such, focusing on company fundamentals and checking metrics such as dividend cover, leverage and free cash flow growth could prove to be more important than simply buying stocks with high dividend yields.
Fortunately, there is a wealth of data available for investors that can be used to assess the dividend reliability of a specific company. Through purchasing a range of the most appealing income stocks, it may be possible to replace your salary with a passive income in the long run.
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Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.