Earning $20,000 in annual passive income from $20,000 in savings may seem out of reach for many ASX investors.
But by investing in the right basket of ASX dividend shares, and importantly reinvesting those dividends, it's a lot easier than you might think.
Now it obviously won't happen overnight. Not unless you know of some ASX shares paying a 100% yield. (If so, drop us a line!)
But with a diversified, high-yielding ASX portfolio, and tapping into the magic of compounding, a little patience should pay off handsomely.
Here's how I'd go about it.
Targeting ASX shares for $20,000 in passive income
Over the past three years the S&P/ASX 200 Gross Total Return Index (ASX: XJT) – which includes all cash dividends reinvested on the ex-dividend date – has gained 30%.
To give you an idea of the importance of dividends and reinvesting those payouts to turbocharge your gains over time, the S&P/ASX 200 Index (ASX: XJO) is only up 15% over that same period.
So by reinvesting my dividends, and with history as my guide, I can comfortably aim for a long-term 10% annual return to build up my passive income stream.
Within the dividend-paying ASX shares, I'd preference companies paying fully franked dividends. That should see me hold onto more of my second income at tax time. (Though we'll stick to the 10% annual returns for the purposes of this article to keep things simple and relatively conservative.)
Now I'd spread my $20,000 across at least five different ASX dividend shares operating across different sectors and ideally in various geographic locations. That kind of diversification will reduce the risk of my passive income taking a big hit if a particular company or sector comes under unexpected pressure.
Now, let's crunch some numbers.
To the maths!
Turning to my trusty compound interest calculator, if I invest $20,000 in ASX shares today at 10% annual returns, I'd have $66,073 in 12 years. If I didn't want to touch my capital (I don't), then that would yield me $6,607 a year in annual passive income.
So, we've got a ways to go before reaching $20,000 a year. Though not as long as you may think.
With compounding working for us, just 12 years later (or 24 years from my initial $20,000 investment in ASX shares) I'd expect to be sitting on a portfolio worth $218,282.
That should allow me to take out $21,828 a year in passive income without drawing down on that investment capital.
