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How much passive income could £5,000 turn into? Like most folk looking to make the best possible investments, I’d hope to get the most bang for my buck out of my yearly ISA allowance. And that means looking at the best and brightest across the London Stock Exchange.
My first thought could be to sort by the largest dividend yields. A quick search reveals companies offering 11%-13% at the moment. That could mean a £550-£650 yearly payout on that five grand I’ve got laying around. Time to shove the money in and cross my fingers? Hold your horses there!
This type of short-termism can be the downfall of many a promising Stocks and Shares ISA. Chasing big yields can lead to big mistakes. We don’t want to blindly invest in the first stock that sounds good. What we really want to do is invest in good companies instead.
Buying low
Take Lloyds (LSE: LLOY) for instance – a stock I own myself. The bank currently pays a 3.26% yield. That’s a nice little income stream – and around the FTSE 100 average – but it’s not exactly an amount that will get a typical investor’s pulse racing.
Had an investor bought into the black horse bank two years ago – when the shares were half the price they are now – the yield would have ballooned. By ‘buying low’ while the shares looked undervalued, the investor would now be collecting over 7% on the original stake.
But now that the banking sector has turned the corner, those dividends are set to rise in the years ahead too. Buying cheap shares like this with room for growth lets the passive income build up through compound interest.
We have to take the rough with the smooth of course. If, for example, interest rates fall faster than expected than that could be a threat to Lloyds’ earnings, dividends and share price appreciation.
It’s all in the detail
With investing, like many things, the devil is in the detail. It’s somewhat easy to point out the shares that have gone gangbusters after the fact. It’s a much harder task to build the kind of portfolio that achieves a significant edge on average market returns.
Following a strategy can help. Having a few key rules that an investor sticks to can prevent some of the worst mistakes that are possible to be made. One of the rules we follow here at The Motley Fool is to buy stocks with the intention of holding for a decade or longer.
Lloyds is a good example of this. It has had a terrific few years, it’s true. But I didn’t buy for short-term profit-taking. I intend to hold my position for many more years to come.
Time is really the key factor with investing. Letting the years roll by and the earnings will build up like a snowball. Not that there are any guarantees, but enough time in the right stocks can easily mean a £5,000 stake can end up returning more passive income than seems initially possible.
