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Most of us invest for a passive income. Typically, however, we’re not looking for a passive income today, we’re building a portfolio for a passive income in the future.
So, how’s it done?
Well, if we’re starting from nothing, which many of us are, it should probably begin with opening a Stocks and Shares ISA. This vehicle allows us to invest in shares, funds, trusts, bonds, and other asset classes without being taxed on the returns — capital gains or dividends.
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.
The next step is deciding how much we want to invest. In this example, I suggest £800 per month. Ideally, this would be on a direct debit or subscription to encourage good investing habits.
And with £800 a month, an investor could realistically have a portfolio worth £471,216 after 20 years. This assumes a very achievable 8% annualised return on investment. Some novice investors do worse, some experienced investors do much better.
And with £471,216, an investor could look to achieve £1,963 per month by investing in dividend-paying stocks or even bonds that yield 5% on average. This is a little more than the yield people typically take on a pension — but this isn’t a pension.
The hidden magic
That impressive £471,216 figure highlights the power of compounding. Compounding works like a snowball rolling downhill — the longer it rolls, the bigger it gets.
Each year, returns are generated not only on the money invested but also on the returns from previous years. Over time, this creates exponential rather than linear growth. Even modest, consistent contributions can build substantial wealth when left to compound.
The key ingredients are time and discipline: the earlier one starts and the more consistently one invests, the greater the compounding effect.
Where to invest
Investors looking to beat the market will typically look to invest in individual stocks. This gives them greater exposure to the companies they believe will outperform.
Jet2 (LSE:JET2) shares appear to be among the most undervalued in the UK market, and I certainly believe the stock is worth considering.
According to the 12 analysts currently covering the stock, it’s undervalued by as much as 47%. While analysts aren’t always right, such broad consensus is rare — and worth paying attention to.
The company does face some challenges. Rising costs, including higher wages, employer insurance contributions, and airport fees, are expected to limit earnings growth to around 4% annually in the medium term. This helps explain why the stock has fallen since the summer.
However, Jet2 trades at just 6.4 times forward earnings and holds an impressive £2.1bn in net cash. That’s only £500m less than its market capitalisation.
Coupled with strong fundamentals and a sustainable fleet renewal programme, Jet2 looks far too cheap to ignore.
