£13k in savings? Here’s how I’d aim to turn that into passive income of £1,487 a month

Trader on video call from his home office

Passive income is every investor’s dream: simply sit back and relax while the money rolls in! I would sleep in late, avoid the morning traffic, and spend the day doing as I please.

But building up to that point is not easy, which is why I’m starting early.

There are several ways to earn income passively but I think the best is through dividend shares. These are shares that pay a certain percentage of earnings to investors annually. A dividend yield is the percentage of the share price that is paid out.

For example:

A 10% dividend yield on a £1 share will earn me 10p for each share I own.

By investing in dividend shares, I could eventually earn enough from them to live off. However, if the value of my investment decreases then I risk losing more money than the dividends pay out.

What shares should I choose?

Since 1984, the average annual price return of the FTSE 100 has been 6.8%. By simply investing in an FTSE 100 index fund, I could achieve similar returns. However, to profit from dividends I would need to build my own portfolio of stocks that pay a regular dividend.

One example is Record (LSE:REC), a provider of derivative management services in the UK and internationally. Record has its own an excellent track record of paying a high dividend, with a current yield of 7.76%.

However, over the past three months, many Record insiders have been selling their shares. This likely contributed to the price falling 27% in the past year. If it continues to do so, that would negate my dividend profits.

But the low price could also be a good buying opportunity. Some analysts estimate Record to be trading at 10% below fair value and forecast future earnings to grow at 5% per year. I think 2023 was a tough year, so I believe the Record share price will go up again when the market improves.

Other examples of good dividend-paying UK stocks to invest in today include Vodafone, HSBC, and ITV. But companies change their dividends often, so I’ll be on the lookout to add new stocks to my portfolio regularly.

How long will it take?

To estimate the time needed to reach £1,487 of passive income a month, we can use industry averages.

While some FTSE 100 companies pay much higher dividends, I think 6% is a good average to work on. I can expect a well-diversified selection of FTSE 100 stocks to achieve close to an average 7% annual return, as noted above. Using these figures, it would take me over 45 years to reach my goal with only £13,000.

That isn’t ideal, as it puts me past my desired retirement age.

To get the total down to 20 years, I would contribute a further £180 a month into my investment and use a dividend reinvestment plan (DRIP). The compounding returns would grow my investment to £331,112 in 20 years, paying out an annual dividend of £17,842 a year — approximately £1,487 a month.

At this point, I could start withdrawing the dividend payments — or continue reinvesting them to secure even more passive income.

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HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Mark Hartley has positions in Vodafone Group Public. The Motley Fool UK has recommended HSBC Holdings, ITV, and Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.