If you want to generate passive income from ASX shares, you don't have to start with a huge lump sum.
Making small contributions on a monthly basis has the potential to snowball into something significant in the future. This is because of the power of compounding, which is what happens when you earn returns on top of returns.
It explains why a 10% per annum return will turn $1,000 into $1,100 after one year and then $2,000 after just over seven years.
The good news is that a 10% return is achievable with ASX shares. In fact, it is largely in line with the average return that Australian shares have generated over the last 30 years according to Fidelity.
That's despite the global economy going through numerous crises during this period such as the dot-com bubble bursting, the GFC, and COVID-19, to name just three.
And while nobody knows what will happen over the next 30 years, I don't believe it is farfetched to expect similar returns. As a result, we are going to base our calculations on this expected return.
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Building passive income on $100 a month
If you were to invest a modest $100 a month into ASX shares and generated an average 10% per annum return, you would grow your wealth to $40,000 after 15 years.
At that point, investors could switch their focus to income and sit back and count the dividends coming in.
For example, Goldman Sachs estimates that Westpac Banking Corp (ASX: WBC) shares currently offer a forward fully franked yield of 6.7%. Investing $40,000 into its shares would lead to a passive income of approximately $2,700 per year.
But why stop there? If you're thinking longer term, then it would make sense to keep investing in order to grow your wealth further.
Let's say that we were to do the same again: $100 a month for 15 years but with a starting balance of $40,000. If you were to continue to generate an average 10% per annum return, your portfolio would grow to be worth almost $210,000.
This time, Westpac's shares would boost your passive income with dividends of approximately $14,000 per year.
Want even more?
Okay, let's keep going to see what will happen in a further 15 years.
Ceteris paribus, your portfolio would grow to be worth almost $910,000 and your dividends would come to approximately $61,000. Not a bad passive income!
Interestingly, these dividends are actually more than the $54,000 you would have invested during the entire period.
I believe this demonstrates just how powerful compounding is and how investors can use it to their advantage to grow their wealth.
