The allure of a passive income stream is the financial independence and freedom it provides. Most people consider time as one of the most important things in their lives and building a passive income stream could be the answer to give you more of that exact thing, time.

How do you build a passive income stream?

There is no magic answer to this question. Quite frankly, for most, it involves a lot of discipline and hard work. I will work through this question, but really it comes down to building an asset base as quickly as possible.

The first step is working through your objectives and determining how much passive income you would like to derive. This usually involves completing a budget to understand your spending habits. Let’s assume that figure is $50,000 per annum.

To generate $50,000 per annum, you need to build a capital base to support this level of income. At Hewison Private Wealth, we build bespoke tailored portfolios that can generate income of around 5% per annum. I am only referring to an income of 5% and we would expect a diversified portfolio with exposure to growth assets such as shares and property to also provide capital growth over time, increasing the total return.

Therefore, someone wanting a passive income of $50,000 per annum would require a capital base of $1 million in today’s dollars earning an income of 5% per annum.

Another way to think about this is the rule of 20 ($50,000 x 20 = $1 million). In this example, a capital base at this level would be ideal to allow someone to generate an annual income of $50,000 without having to draw down on the portfolio’s capital base.

Now the hard part is building the capital base. As I mentioned earlier, it usually involves hard work. The younger you start investing and generating an investment return that can compound over time the better. I can appreciate this is easier said than done, especially when life events such as purchasing a family home may require capital to be directed elsewhere.

To give you a feel for the numbers and what you need to do to build a capital base of $1 million. If you were starting at ground zero with no capital, to build $1 million over 20 years, you would need to put away $1,700 per month ($20,400 per annum) at an 8% total annual return to accumulate that $1 million. Please note this example does not account for inflation.

The following website is useful when looks at these numbers.

https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/compound-interest-calculator

We strongly recommend that you seek independent financial advice to navigate these matters. Some key considerations are which investments to select and to determine what is the appropriate asset allocation. Diversification is also important to protect this income stream. Colleague, Glenn Fairbairn and I. also discuss how to create and determine what passive income stream you will need as you transition to retirement in our most recent podcast which you can listen to HERE.