The passive income potential from ASX shares can make a big difference in your retirement.
Or, if you reach your income goal before retirement, ASX dividend shares can provide some handy monthly cash while you're still working.
And with the franking credits offered by many ASX dividend stocks, that could see you holding onto more of that passive income come tax time.
Of course, you're not going to garner $500 a month, or $6,000 a year, in passive income from ASX shares overnight.
So, here are three steps I'd take to reach that goal.
Save and make monthly investments
To get to my goal of $500 a month in passive income from ASX shares I'd make the most of the magic of compounding.
And I'd set aside $100 (or more if I could) each month to invest in quality ASX dividend stocks and let those investments ride over time. I'd also re-invest the dividend payouts from those stocks to get to my goal faster.
To give you some idea of the sizeable difference that can make, the S&P/ASX 200 Index (ASX: XJO) is up 13.4% since 3 May 2019.
Over that same time, the S&P/ASX 200 Gross Total Return Index (ASX: XJT) – which includes all cash dividends reinvested on the ex-dividend date – has gained 32.7%. That works out to more than 8% in gains annually.
Invest in top-quality ASX dividend shares
After I've worked out my savings plan, it's important to do thorough research on which ASX dividend shares look best placed to deliver reliable, outsized passive income.
And it's not as easy as choosing the stocks paying the highest yields today. Those yields are trailing yields, based on the past 12 months of payouts.
While some high-yielding ASX shares may continue to deliver, next year's top passive income stocks often won't match up to those leading the pack last year.
As a rule, I'd generally stick to ASX 200 stocks, as there's more research readily available. And many of these companies have long track records of paying regular, fully franked dividends.
I'd also keep this investing nugget from Warren Buffett in mind, "Look for companies with great brands and the ability to control prices."
Watch that passive income stream build up
Once I have a diversified portfolio of ASX shares, I'd continue to add to my holdings each month accordingly.
If I match the 8% annual performance of the ASX Total Return Index, investing $100 a month would see my portfolio grow to $124,856 in 28 years.
If, at that time, I'm earning an average yield of 5% from my ASX dividend shares, that would translate to a bit more than $520 per month in monthly passive income without having to draw down my portfolio.
