Gaining a stream of passive income of $84,567 every year would be a dream come true for most Australians.
After all, that stream of income is above the median salary in Australia and orders of magnitude higher than the Age Pension. It would effectively make working optional and give most of us the opportunity to retire whenever we want.
But dreaming of passive income is the easy part. Actually obtaining that level of secondary income is where things get a little tricky.
Here at the Fool, we regularly preach that dividend income from ASX shares is one of the best ways to enjoy passive income. For one, dividend income is truly passive, requiring almost no effort to obtain, aside from the capital investment of course. But dividend income is also tax-effective income, thanks in no small part to the benefits of franking that most dividend payments come with.
But is it even possible to secure passive income worth $84,567 a year from ASX dividend shares if we have $200 a month to invest?
Well, yes. But it will take a lot of time, discipline and patience.
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Investing in ASX shares for passive income
Perhaps the most straightforward path to gaining a passive income stream of the magnitude we are discussing is to invest $200 per month into an ASX index fund like the iShares Core S&P/ASX 200 ETF (ASX: IOZ). An index fund like IOZ invests in 200 of the largest shares on the Australian share market, giving an investor an 'average' return of the ASX.
This exchange-traded fund (ETF) has returned an average of 8.28% since its ASX inception in 2010. Not a bad return, objectively speaking.
Let's assume this rate of return will continue (which is not guaranteed, of course). If it did, investing $200 a month would result in a lump sum of around $1.17 million after 45 years. That means that someone who started when they were 20 would end up with a pretty tidy nest egg by the time they are approaching retirement. However, under the 4% rule, this would still only get them a passive income stream worth $46,687 per annum.
Of course, that's nothing to turn one's nose up against, but it's still not even close to that $84,567.
So what is one to do? Well, the only way to increase returns is either to increase our investing amount, or achieve a higher rate of return. Since the former is obvious, let's focus on the latter.
Boosting your returns
Investing in index funds is a great strategy for most investors. But, it is possible to gain better returns by investing in individual shares yourself.
The ASX is full of shares that have outperformed the broader stock market over the past ten years. Some examples include WiseTech Global Ltd (ASX: WTC), Xero Ltd (ASX: XRO), Commonwealth Bank of Australia (ASX: CBA), and Washington H. Soul Pattinson and Co Ltd (ASX: SOL). Again, just because a stock has outperformed the broader market in the past doesn't mean it will continue to do so.
However, the fact remains that if you do manage to find stocks that can deliver market-beating performance, you can turbocharge your path to high levels of passive income.
Let's assume that you invest in a portfolio comprising both index funds and a few top ASX stocks. If you pull this off and achieve an average annual return of 11% per annum instead of 8.28%, that same $200-a-month investment will result in a final portfolio value of $2.11 million after 45 years.
And 4% of that $2.11 million would equate to an annual passive income of $84,567.
