How to turn £7 a day into passive income for life

Story by Zaven Boyrazian, MSc

The Motley Fool

Close-up of British bank notes© Provided by The Motley Fool

Even when starting with zero savings, investing a modest sum of cash each day can potentially unlock a substantial passive income in the long run. Putting aside as little as £7 a day can be transformative to an investor’s wealth given sufficient time. Here’s how.

Saving little and often

Investing this money into top-notch dividend shares could instantly start generating a passive income overnight. But how much can investors realistically expect? This ultimately depends on the yield they manage to secure.

For index investors focusing on the FTSE 100, the average dividend payout by the UK’s flagship index is around 4%. Therefore, every £200 investment is roughly equal to an extra £8 in annual passive income. Of course, for stock pickers, this figure can be bolstered by being more selective. Building a portfolio yielding closer to 6% pushes this income to £12 – a 50% increase.

After a year of investing £200 a month at this rate, the income from a brand-new portfolio would be £144. Obviously, that’s not life-changing. But given time to compound, this can start to add up. After a decade, the income stream would grow to just under £2,000 – and even that might be conservative since it doesn’t include the extra returns generated from capital gains or future dividend hikes.

Of course, share prices don’t always go up. And a poorly constructed portfolio can easily end up backfiring. So, how can investors find the best income stocks to buy?

Picking the right shares

Stock picking is a complex process with countless aspects that investors have to consider. However, there are a few known shortcuts, especially for dividend shares. When hunting for companies that can systematically increase their shareholder payouts, investors could spend time analysing free cash flow, or they could just jump straight to the list of dividend aristocrats .

Does that make it the perfect solution for building a passive income? Not necessarily.

As with any investment, proper due diligence is required. And while it’s true that National Grid has raised dividends for more than a quarter of a century, the average annual growth rate has only been a modest 3.4%. Even in a normalised inflationary environment, the level of wealth created in real terms is pretty minimal. In other words, while the dividends may be “safe”, they may be a poor fit for an individual looking to build wealth.

However, that’s not always the case. Several Dividend Aristocrats have been growing payouts at a far more meaningful pace, some even in double-digit territory. And these could be the key to turning a £7 daily investment into a five-figure passive income for life.