National Australia Bank Ltd (ASX: NAB) research earlier this year found that the average Australian has about $34,500 in their bank account.
So for many people it's not unrealistic to scrounge together $20,000 to start an investment portfolio.
If you can manage that, we can explore turning that into a machine that generates a tidy flow of passive income for life.
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Let's bake the dough into a big cake
Firstly, the $20,000 needs to grow.
You could achieve this by creating a portfolio of ASX growth shares. Remember to diversify so that you reduce the risk of any one stock plunging.
As an example, you could buy into Lovisa Holdings Ltd (ASX: LOV), Johns Lyng Group Ltd (ASX: JLG) and Xero Limited (ASX: XRO).
They all have decent long-term growth prospects, but are in three different industries — retail, insurance repair and technology.
The three businesses all have different internal and external drivers that could push up their valuation in the coming years.
That's a nice mix.
While remembering past performance is no indicator of the future, we need some numbers to calculate the potential of such a portfolio.
Over the past five years, the Johns Lyng share price has rocketed 389%, Xero has gained 139%, and Lovisa just above 111%. That's including market traumas such as the COVID-19 crash and the 2022 growth correction.
For our demonstration, let's take the median compound annual growth rate (CAGR) from the three stocks, which is 19%.
At this rate, your initial $20,000 will have turned into $113,893.68 after 10 years.
You reckon you could chip in $100 each month over that time?
Then your nest egg will be $143,544.
Now let's eat the cake and have it too
Now let's see how we can produce passive income out of that portfolio.
One way to go would be to sell all those growth shares and buy a bunch of ASX dividend shares with high and reliable yields.
Again, you'll want to diversify to reduce the risk of any one stock bringing the whole house down.
Three dividend stocks you could pick right now could be Ampol Ltd (ASX: ALD), HomeCo Daily Needs REIT (ASX: HDN) and BHP Group Ltd (ASX: BHP).
All provide excellent dividend yields, while playing in distinct sectors — energy, commercial real estate and minerals.
BHP is paying out 9.1%, Ampol 8.2%, and HomeCo Daily Needs 5.4%.
If, once again, we take the median of those, your portfolio could provide you annual passive income of $11,770.
How good is that! What could you do with an extra $11,770 each year?
One catch with this approach is that, depending on your personal circumstances, selling all those growth shares could trigger capital gains tax obligations.
To avoid that liability, one could simply keep the portfolio as it is.
Then each year, just sell the growth gained the previous 12 months.
Maybe all three of Lovisa, Xero and Johns Lyng are more mature by this stage and can't deliver 19% a year.
Even if the portfolio can provide 8.2%, this will match the passive income produced from the dividend stocks scenario.
The downside of this second method is that growth in share price can fluctuate wildly.
One year you may not see any passive income, while other years you could be raking it in. This is the trade-off you have to be willing to accept.
Good luck!
