I believe that ASX shares are the right tool to unlock significant passive income for Australians. Eventually, the cash flow could grow to the point where it could replace our main source of income.
ASX shares aim to generate a profit for shareholders each year, which they can distribute to investors in the form of dividends.
But it takes money to make money with investing. So, I'd encourage investors to start finding savings so they can put money to work and eventually reach an annual passive income of $70,000.
Earnings and savings
Everyone makes their money in different ways, but it needs to come from somewhere if we're going to have money to invest.
To have money to invest at the end of each month, we need to spend less than we earn. That may not be possible for some households, but there are ways to both boost income and reduce spending.
Whether that's taking a course, doing professional development or some sort of qualification, it's usually a good move for one's career (and earnings) to invest in education and upskilling. Having a side hustle or finding another second income could also be helpful.
On the spending side, getting value for money for what we buy is a good step. That could mean asking the bank whether the mortgage is on the best interest rate, trying shopping at better-value stores, buying items when they're on sale, and so on.
After creating that surplus in monthly cash flow, we can then start putting it into a savings account so it's earning interest until we invest it.
Invest in ASX shares
Once we have some money to work with – I think (at least) around $1,000 is a good figure to ensure relatively little brokerage fees – we can start putting it to work for passive income.
The simplest way to invest is to put money into exchange-traded funds (ETFs), which can provide investors with good diversification and potentially good long-term returns.
Some of my favourite ETFs are names like Vanguard MSCI Index International Shares ETF (ASX: VGS), VanEck MSCI International Quality ETF (ASX: QUAL) and Betashares Global Quality Leaders ETF (ASX: QLTY). These ETFs provide investors with exposure to the global stock market, with a high exposure to quality names.
Individual ASX shares can also make excellent long-term picks. Names like Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), Wesfarmers Ltd (ASX: WES), Xero Ltd (ASX: XRO), Pinnacle Investment Management Group Ltd (ASX: PNI), Breville Group Ltd (ASX: BRG) and TechnologyOne Ltd (ASX: TNE) are examples of long-term compounders.
Over time, investing regularly combined with investment returns can help grow our portfolio value.
Be a patient compounder until reaching the passive income goal
Becoming a millionaire takes more than a year, but the power of compounding can help accelerate our financial growth.
Over the long term, ASX shares have generated roughly an average annual return of 10%.
If someone invested $1,000 per month and it grew at an average annual rate of 10%, it'd turn into $1.33 million after 25 years.
Investing $2,000 per month and achieving an average annual growth rate of 10% would result in $2.65 million after 25 years.
I don't know what dividend yields different investments will have in 25 years, but with a $2.65 million portfolio, an investor could aim for a dividend yield of just 2.6% and receive $70,000 of annual passive income.
If someone had a $1.33 million portfolio, they'd need to have an average portfolio dividend yield of 5.25% to achieve a $70,000 annual dividend income – I think that's a very achievable yield.
