Can you imagine earning an extra $10,000 a year in passive income from an S&P/ASX 200 Index (ASX: XJO) dividend stock?
That may not be a lifechanging amount. But watching that cash hit your bank account without having to lift a finger would certainly be nice. Especially during those golden retirement years.
But is it really possible to achieve that much passive income with an initial investment of only $10,000?
We'll have a look at an ASX 200 dividend stock below that I believe can help deliver just that.
But first…
Diversify and invest for the long-term
While we'll look at just one leading ASX dividend stock below, a proper passive income portfolio will contain a larger number of stocks (10 is a decent ballpark figure). Ideally, those will operate in different sectors and geographic locations. That kind of diversity will decrease the chances of your income stream taking an outsized hit if any single company or sector hits a rough patch.
Also, note that the yields and share price gains you generally see quoted are backward-looking. Future yields and gains may be higher or lower, depending on a range of company-specific and macroeconomic factors.
And finally, investing is a long-term game. Yes, some ASX stocks can double your money or more in a matter of months. But those are the exceptions, not the rule.
Unless we can find a stock with a consistent 100% yield – we can't – then it will take a bit of time to build $10,000 in yearly passive income from our initial $10,000 investment.
With that said…
Building up to that $10,000 annual passive income stream
The ASX 200 stock I'd put $10,000 into today to achieve a $10,000 annual passive income stream is Fortescue Ltd (ASX: FMG).
In making this investment, I wouldn't be concerned about the short to medium term moves in iron ore and copper prices. Instead, I'd invest with confidence that these industrial metals (and other commodities Fortescue mines produce) will remain in strong global demand for the foreseeable future.
Atop what I believe is a solid ongoing growth path, I also like that Fortescue's dividends come with full franking credits. That should enable me to hold onto more of that passive income at tax time.
So, at yesterday's closing price of $19.73, I'd be able to buy 506 Fortescue shares with enough change left over for a burger.
Fortescue stock trades on a fully franked trailing yield of 10.0%, having paid out $1.97 a share in dividends over the past year. While that's on the higher end, I believe it's a sustainable longer-term yield for the ASX 200 miner.
That means my $10,000 investment would earn me a rounded $1,000 a year in passive income.
Which is well short of our goal. And that's where a bit of patience comes into play.
To calculate what kind of returns I might expect in the years ahead, we'll take the past five years as an average that could be repeated. And this isn't cherry-picking any particular low point from the past.
Now, as you can see on the chart below, five years ago Fortescue shares were trading for $8.81 apiece. That saw the Fortescue share price up 124% over five years at market close yesterday.
Of course, that's not including the 10 dividends paid out over this time. Those work out to a total passive income payout of $11.13 a share.
If we add those back into yesterday's closing price, we get an accumulated value of $30.86. Or a 250.3% gain over five years.
But let's err on the conservative side here and say that over the years ahead, Fortescue shares (with dividends included) will gain a far more modest 20% a year.
If that's the case, and we initially reinvest those dividends as they come in, then via the magic of compounding, my initial $10,000 investment in the ASX 200 mining stock today will have grown to $108,073 in 12 years.
At that point, I can begin withdrawing $10,807 a year in passive income from that expected 10% dividend yield without drawing down my capital.
I'll also be hoping Fortescue shares keep marching higher.
