Fancy receiving $500 each month without working for it?
So do I!
Believe it or not, with ASX shares and the magic of compounding, that level of passive income is very achievable.
Let's take a look how you can get there:
Incubate the egg
Before generating passive income, we need to grow a nest egg.
A National Australia Bank Ltd (ASX: NAB) study earlier this year showed the average Australian has roughly $34,500 saved.
To be conservative, let's say you are starting with $30,000.
Here at The Motley Fool, we always advocate diversification to manage risk. So we'll invest that $30,000 into a basket of growth stocks such as Xero Limited (ASX: XRO) and Audinate Group Ltd (ASX: AD8).
Over the past five years, Xero shares have gained about 172% and Audinate has risen 156%.
Past performance is never an indicator of the future. But we need some numbers to work with for this scenario.
Let's assume you've assembled such a portfolio that performs similarly to Vaneck Morningstar Wide Moat ETF (ASX: MOAT). That ETF has nabbed 87% of returns over the last half-decade.
Once again, to be conservative, we'll use the ETF's returns as our example.
That five-year return works out to be a compound annual growth rate (CAGR) of 13.34%.
At this rate, we can expand our nest egg to a handy $111,359 after nine years.
Great work.
Income generation method #1
Now we can think about extracting that sweet passive income from the investment.
There are two ways you can achieve this.
First is to sell out the portfolio and buy up ASX dividend shares, such as BHP Group Ltd (ASX: BHP) and Whitehaven Coal Ltd (ASX: WHC).
They are handing out amazing dividend yields of 8.6% and 10.3%, both fully franked.
However, similar to the growth portfolio, you want your income investment to also be well diversified.
This time let's imagine you have put together a basket of shares that perform similarly to the Vanguard Australian Shares High Yield ETF (ASX: VHY).
At 5.94% dividend yield, mostly franked, it's a decent representation of what you could do without relying too heavily on one particular sector.
So with those distributions, your $111,359 investment will now pay you $6,614 of passive income annually. That works out to be $551 per month, which was our initial goal.
That all sounds great in theory, but the problem with this method is that selling down your growth shares could trigger capital gains tax implications.
Depending on your personal circumstances, this could cost you money not accounted for in these calculations.
Income generation method #2
So what's the other way of getting to $500 of monthly passive income?
Leave the growth portfolio as it is.
Then each year you sell off any gains above and beyond the $111,359.
If the investments can maintain the 13.34% CAGR, that's a juicy $14,855 of annual passive income.
That translates to a stunning $1,237 of income per month.
What's the catch, you ask?
As you already know, shares don't always gain every year. Some years the portfolio will remain flat or shrink, which means no income for you.
So this second method requires an acceptance of volatility in income.
Best wishes for your investments!
