Most ASX investors buy shares to build wealth as quickly as possible and, hopefully, one day, to establish a stream of passive income large enough to help fund a comfortable retirement.
Receiving $3,000 a month (that's $36,000 annually) in passive income from dividend shares is obviously a nice end goal. Unfortunately, my own portfolio is not yet at the stage where it can check that box. But, all going well, it will be one day. I'm certainly planning on getting there. Using the 4% rule, a passive income of $3,000 a month would require a portfolio worth $900,000. That's obviously a tall ask for any Australian.
However, I'm planning on getting there. Remember, the wonders of investing and compound interest mean we don't actually need to save up $900,000 to build a portfolio worth $900,000. We invest in ASX shares, and keep investing (including reinvesting those dividends). If we do this diligently and relentlessly, the capital will do the hard work for us.
Let's dive a little deeper into that process.
Let's say we have found an ASX share or index fund that returns 8% per annum on average (pretty close to the long-term returns of ASX shares). If we invested $10,000 in this share and an additional $1,000 each year for a further 4 years, we would have invested $15,000 of our own capital by year 5. Yet we would have a portfolio worth $20,560.
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The magic of compound interest and passive income
That additional $5,560 of 'free money' is our return on investment, and, assuming the performance remains the same, will grow exponentially, year in, year out. After 20 years of doing the same investing strategy, our investor would have a portfolio worth $92,372, of which only $30,000 would be invested capital.
Fortunately, I am able to put more than $1,000 each year into my ASX stock portfolio. Let's assume an investor with $10,000 can afford to part with $50 each week. In this scenario, they would end up with a portfolio worth $432,269 after 30 years, assuming that 8% return. That's decent, of course, especially considering we've only contributed $88,000 of our own money. But not enough to reach $3,000 per month in passive income using the 4% rule. That's why I try to pick individual stocks with the potential for market-beating returns.
At a minimum, I aim for an annualised return of 12% in my own portfolio. If I do indeed achieve that over 30 years, instead of 8%, my portfolio would be worth $1.12 million by the end of it. That's well above what we would need to hit that $3,000 per month in passive income. In many cases, the rate of return is even more important than the amount of money we can invest.
