Securing $14,000 each year in completely passive income would be an absolute dream for many people. Yet, the opportunity might be more obtainable via ASX dividend shares than you might first think thanks to a little thing called compounding.
The S&P/ASX 200 Index (ASX: XJO) has failed to grow the wealth of most investors this year. However, patient shareholders could still win in the long run if the future bears any resemblance to the past. As demonstrated over the years, exceptional companies — with enough time — can grow exponentially.
That's how investing as little as $200 each month could one day become a small fortune.
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Where I'd start looking for passive income providers
When shopping for future compounders, buying the dip on companies with distressed share prices may not be the most optimal formula for success.
Nearly two-thirds of the top 200 ASX companies have experienced share price falls this year. In some cases, there has been a valid reason for the selldown. For example, loss-making companies now face a very real risk of collapse if they run out of money and fail to raise additional capital.
In saying that, I believe there are many fantastic businesses that have been lumped in with the laggards. The test for any investor is to search for and identify those needles among the proverbial haystack. A few characteristics I'd look for to scout out quality ASX dividend shares include:
- Proven capital allocators: Where capital is reinvested plays a massive role in whether a company compounds its returns or destroys them.
- Skin in the game: Management with meaningful shareholder ownership is more prone to thinking long term and is aligned with shareholders. Decisions will not only impact shareholders' wealth but also their own.
- Defendable and/or growing moat: An advantage over the competition (moat) is usually the defining factor for a company's profit margin. The wider the moat, the thicker the margin, and the greater the shareholder returns over time.
- Ironclad balance sheet: A company's balance sheet is its financial heart. A decent helping of cash will ensure the business is fighting fit even when struck by hard times. Too much debt can clog the arteries of an ASX share.
If you can find companies that tick all the above, I believe you'll be well on your way to unlocking a sizeable stream of passive income.
Reaching $14,000 in annual dividends from ASX shares
Over the past 20 years, the ASX 200 index has delivered a return of 8.1% per year. While the next 20 could be different, there's also a chance it is roughly the same.
If $200 is invested each month compounded at 8% per annum, we could be staring at a $273,892 portfolio in 30 years. Now, if those high-quality ASX shares pay a decent dividend, a yield slightly above 5% (5.1%) doesn't seem out of the question. That works out to be $13,968 in passive income.
The path could be rocky along the way, some investments will sour, and others will flourish. However, I believe investing in ASX dividend shares could be the simplest way to build a commendable passive income for life.
