How I would generate $20,000 of passive income from ASX shares each year

Here's how I would generate huge pay checks from the share market.

Australian dollar notes inside the pocket on jeans, symbolising dividends.

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The Australian share market is a great place to generate passive income.

And while pulling in $20,000 of passive income each year from ASX shares may seem out of reach, with a combination of time, patience, and capital, it could be possible. In fact, history shows that it has been achievable in the past.

But how would I go about generating this sort of passive income?

How to make $20,000 in passive income with ASX shares

The first step is to put my capital to work with ASX shares.

If I can invest $500 a month into the share market, I could build a substantial portfolio over time.

To begin with, I would focus on growing my portfolio before even considering the passive income side of things.

After all, money in the market will compound over time, growing my portfolio and wealth. Whereas if I take out money in the form of dividends, I'm holding back my portfolio's growth potential.

With that in mind, I would focus on investing in high-quality companies with long track records, positive growth outlooks and competitive advantages. Any dividends I receive, I would reinvest back into the market.

Many ASX shares offer dividend reinvestment plans (DRPs). These allow shareholders to automatically reinvest their dividends in additional shares, often at a discounted price.

Compounding returns

The next step is to let compounding work its magic and grow my wealth.

Historically, the share market has generated a return of approximately 10% per annum.

It is important to note that there's no guarantee that this will happen in the future, but I'm going to base my calculations on this figure.

If my portfolio achieved a 10% annual return and I invested $500 a month into ASX shares, in 10 years I would have grown my portfolio to just over $100,000.

It may still be a little too soon for me to start thinking of passive income. Instead, I would carry on doing what I'm doing and continue to build wealth.

For example, if I were to continue investing $500 a month into my portfolio and achieved a 10% per annum return, my portfolio would grow to be worth approximately $400,000 after a further 11 years.

At this point, I can now start thinking about passive income.

Pay day

If I were to rebalance my $400,000 portfolio with a focus on dividends and averaged a yield of 5% across it, then I would pull in $20,000 in passive income each year (and growing).

Overall, I believe this demonstrates that a significant passive income is possible from even relatively modest investments. It just takes a combination of patience, diversification, investing in quality, and consistent reinvestment of dividends.

Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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