I think investing on the London Stock Exchange is the best way for me to make a passive income. With an average annual return of around 9%, a regular investment in UK shares could set me up with a healthy flow of cash for retirement.
If I was preparing to invest £500 a month, here’s how I’d do it.
1. Think about tax
The first thing I’d do is open a tax-efficient Individual Savings Account (ISA) and/or a Self-Invested Personal Pension (SIPP).
Over the long term, these instruments can save investors a fortune in tax. HMRC can’t take a penny in either capital gains or dividend income. And the annual allowances on them are pretty generous.
With a Stocks and Shares ISA, I can invest up to £20,000 a year. I can also buy shares using a Lifetime ISA, but the maximum here is £4,000, and I can’t draw on my funds until the age of 60 without incurring penalties.
But it’s not all bad. With a Lifetime ISA, I also get a 25% annual bonus on my contributions from the government. Depending on when I want to draw down my cash, a good idea could be to max out that £4,000 annual allowance, and to invest the rest in a Stocks and Shares ISA to reach my £20k total ISA limit.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
As I say, I also have the option to invest in a SIPP. I can contribute a sum equal to my annual earnings to a maximum of £60,000, which could allow me to invest more than the ISA.
I also receive large tax relief on my contributions via the government. However, under current rules I can’t draw down any money until I’m in my late 50s.
2. Diversify
The next thing I’d do is look to invest across a wide range of different stocks. I’d seek a mix of growth, value and dividend shares, and build a portfolio that gives me exposure to a variety of different sectors and geographies.
This can boost my chances of making a consistent return over time and all points of the economic cycle. It allows me to harness different investment opportunities and to reduce risk.
A top ETF
One way I could effectively diversify is by investing in an exchange-traded fund (ETF). One I’m looking at right now is the Vanguard FTSE 250 UCITS ETF (LSE:VMID), which has positions in hundreds of London’s largest listed companies (bar those on the FTSE 100).
One drawback is that the index it tracks generates a large proportion of earnings from cyclical sectors like financials and consumer discretionary. So it could underperform when the global economy struggles.
However, its diversification across many sectors may limit any potential volatility, as might its exposure to international markets. Just over 40% of earnings come from outside the UK.
What’s more, the FTSE 250 consists of companies that often have greater growth potential than Footsie stocks. And the annual charge on this particular fund is dirt cheap, at just 0.1%.
Using these principles, a £500 regular monthly investment in this ETF could — based on an average annual return of 9% — provide me with £915,371 after 30 years. I could then draw down 4% of these each year for a tasty yearly passive income of £36,615.
