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Being able to generate a large and passive income is the dream for most investors. We only have limited time on this earth, so finding ways to become financially independent and just enjoy life is paramount.
There are plenty of ways to try and source a second income, from owning buy-to-let property, to buying dividend shares, and starting an online side-hustle. Here’s one strategy I’m optimistic could give someone with a £20,000 lump sum, and the ability to make regular top-ups, the chance to make a an annual passive income above £45,000.
1. Reduce the tax burden
The greatest ‘expense’ that any of us face isn’t rent, bills, or even inflation — it’s tax.
Share investors, facing capital gains tax (CGT) of 18% to 24%, and dividend tax of between 8.75% and 39.35%, often pay tens of thousands of pounds to HMRC over time. Annual allowances of £3,000 for CGT and £500 for dividends do little to shield substantial allowances from the tax authorities.
And with tax rates on the rise, it’s more important than ever to reduce (or ideally eliminate) any payments one makes to HMRC. This can be achieved easily with the Individual Savings Account (ISA), for instance, via which Britons can save or invest £20,000 each year.
Given the potential for stronger long-term returns, Stocks and Shares ISA investors stand to benefit even more in tax savings compared to those using an (admittedly safer) Cash ISA.
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.
2. Diversify for growth and safety
Obviously the potential for greater returns means share investors have to absorb a higher degree of risk. Cash in the bank stays stable over time. Stock markets go up as well as down.
However, the possibility for truly life-changing returns may make share investing a better choice for many.
Investors can tailor their portfolios to manage the amount of risk they’re prepared to take. They could, for instance, consider building a portfolio of defence, utilities, healthcare and consumer staples stocks to help them balance growth and safety. Purchasing a healthy number of shares (say 10-15) across different industries can also protect returns from turbulence among one or two companies or industries.
An exchange-traded fund (ETF) holding a basket of currencies can be a quick and easy way to achieve this diversification. The Vanguard FTSE All-World ETF (LSE:VWRP) is one such financial vehicle I think is worth considering to spread risk.
A passive income creator
Tracking the FTSE All-World Index, this fund comprises of 3,624 blue chip shares and mid-cap growth stocks across developed regions. Just under 63% of its holdings are located on US stock markets, meaning investors have exposure to quality market leaders and innovators like Nvidia, Apple, Visa, Caterpillar and Palantir.
Since its creation in 2019, this Vanguard ETF has delivered an average annual return of 9.9%. That’s at the upper end of what share investors can realistically expect each year. And if this continues, someone with a £20,000 lump sum and £400 monthly put in this fund would turn this into £757,012 after 25 years.
This could then deliver a £45,421 yearly passive income if invested in 6%-yielding dividend shares. I think it’s worth considering, even if its high weighting to US stocks could leave it vulnerable to a possible Stateside recession in the near term.
