If you have a New Year's resolution to start investing and have passive income in mind, then here's how I would go about it.
Firstly, let's imagine you have $500 to invest. While this might not seem like it could grow into anything substantial, history shows that it can.
Over the last 30 years, the Australian share market has delivered an average return of 9.6% per annum.
Thanks to the power of compounding, this means that a single $500 investment 30 years ago would be worth almost $8,000 today.
Sure, that's not necessarily going to change your life, but that's just a single investment. If you contribute to your investment portfolio on a regular basis, compounding can go into overdrive and help you generate meaningful wealth and passive income.
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Passive income with a $500 investment
Let's assume you are able to start with a $500 investment and then add $100 each month to ASX shares.
By doing this, your investment portfolio would grow to be worth $200,000 in 30 years if you were to achieve the market return of 9.6% per annum.
If you were to then construct your portfolio so that it averaged a 5% dividend yield, your $200,000 investment would bring in a passive income of $10,000 a year.
Think you could afford to contribute a little more? Well, if you could put $250 into ASX shares each month, then you will really start to create some wealth.
All else equal, you would have a portfolio valued at almost $500,000 after 30 years. Once again, with an average 5% dividend yield across your portfolio, you would be pulling in $25,000 in passive income each year.
And with your portfolio still expected to increase in value by 4.6% per annum (9.6% minus your 5% yield), your passive income stream would increase by that margin each year thereafter if all goes to plan.
This means that in five years your annual income would be $31,000 and in ten years it would become over $39,000. All without lifting a finger!
But which ASX shares should you buy?
I would focus on quality over quantity and build a portfolio filled with companies that have strong business models, sustainable competitive advantages, fair valuations, and positive long-term growth outlooks.
These are qualities that Warren Buffett looks for when he invests. And given his success over multiple decades, it is hard to argue against this strategy.
One option that ticks all these boxes is the Vaneck Morningstar Wide Moat ETF (ASX: MOAT). It has a track record of delivering market-beating returns and I believe this can continue long into the future.
