So you're starting out with $0 in savings, but you want to build an annual passive income stream of $20,000? Well, you've come to the right place, and every 1,000-mile journey starts with a single step.
Getting from nothing to a passive income of $10,000 per year isn't going to be easy. But it is certainly doable using the best asset class for building wealth – ASX shares – if you follow these three steps.
3 steps to a $20,000 passive income
Set money aside every week to invest
You can't hope to build a source of secondary, passive income unless you have capital to put aside each week to invest. And you can't do that if you have a debt to your name (outside a mortgage). So if you have outstanding credit cards, personal loans or car loans, you need to clear those from your books before anything else.
Once you do that, you need to take a look at your budget and decide on a figure you can put away each week (or month if you'd like). This needs to be a consistent figure that you can afford to put aside without fail. So make sure you account for a rainy day fund to cover those emergencies we all have to find money for every now and again.
Find passive income-generating investments you are comfortable investing in
Now that you've got a budget surplus you can direct towards passive income-producing shares, it's time to choose investments that will get you to a secondary income of $10,000. Some investors will opt for building a portfolio of individually-selected companies. You might like the look of dividend payers like Commonwealth Bank of Australia (ASX: CBA), Telstra Group Ltd (ASX: TLS) or BHP Group Ltd (ASX: BHP), for instance.
Other investors instead go down the index fund route. An exchange-traded fund (ETF) like the iShares Core S&P/ASX 200 ETF (ASX: IOZ) is an easy investment to use for building passive income. That's because it simply holds the largest 200 shares on our share market, most of which pay out decent dividends.
Now that you've budgeted for your passive income stream and selected the investments that will get you there, all you need to do is let time and compound interest work their magic. But I won't sugarcoat this. Getting from $0 to $20,000 in annual passive income won't happen overnight.
Let time and compounding work their magic
Over the past 12 months, investors in the IOZ ETF we've just discussed have enjoyed a dividend yield of approximately 4.47%. A portfolio of individually selected dividend shares would probably give you a similar yield. That's depending on which shares you choose though.
At this dividend yield, you would need a total of roughly $450,000 invested in order to secure a passive income of $20,000 per year.
That will take time to get to, to be sure, but it's not impossible.
The IOZ ETF has returned an average of 8.13% per annum, over the past ten years (assuming dividend income is reinvested). Let's assume this rate of return continues, which is not guaranteed of course. If someone was able to put aside $100 a week, it would take just under 26 years to get to a figure of $450,000. We could then use that lump sum to generate $20,000 per year in passive income.
Foolish takeaway
So there's your roadmap. Of course, if you're able to put away more than $100 a week, the time it will take to secure your passive income stream will be cut. If you are able to set aside $200 a week, you'd be down to just over 18 years.
That's obviously a long time. But if an investor started on this path when they turned 20, they would have a substantial second income of $20,000 a year by age 46 if they invested $100 a week. That's getting close to as much as the full pension.
