There are a lot of ways for Australians to generate passive income.
This includes term deposits, savings accounts, and side hustles, to name just three.
But one of the best ways could be by investing in ASX shares. Especially if you have a long term mindset.
That's because many ASX shares will reward their shareholders with dividends each year. This is a powerful source of passive income that has the potential to grow materially in the future.
Passive income from ASX shares
Let's imagine that you have the goal of generating $500 of passive income each month. This is the equivalent of $6,000 a year.
There are plenty of ASX shares out there that provide investors with dividend yields of 5% or greater.
For example, intellectual property services company IPH Ltd (ASX: IPH) and agricultural property company Rural Funds Group (ASX: RFF) are forecast to provide yields closer to 6% in the near term. But let's settle for a 5% dividend yield for this example.
With that in mind, a $120,000 investment portfolio providing this yield would generate $6,000 of passive income each year or $500 a month if distributed accordingly.
Well, that's job done if you are lucky enough to be sitting on these funds.
But wait! What if you don't have $120,000 to invest? Don't worry, there's another way to get there. It just requires a combination of time and patience.
Compounding
If you can afford to put $500 into ASX shares each month, you could build a $120,000 investment portfolio in just over a decade thanks to compounding.
Compounding is what happens when you earn interest on top of interest or returns on top of returns. It accelerates your wealth building and the longer you leave it uninterrupted, the better.
Based on an estimated (but not guaranteed) average annual return of 10% per annum, $500 a month would turn into $120,000 after approximately 11 years and two months. This assumes that investors reinvest any dividends that are earned during the timeframe to take full advantage of the power of compounding.
It is also worth noting that investors could potentially get there even quicker if they can contribute more to their investment portfolio.
A $1,000 monthly investment in ASX shares would grow to become worth $120,000 in seven years if compounding at 10% per annum and all dividends are reinvested.
Overall, I believe this demonstrates the passive income potential of ASX shares. Investors just need to find a plan that works for them and then stick with it.
