Here's my 5-step approach to earning passive income of $1,000 a month

It goes without saying that we'd all like a stream of passive income that can pay us at least $1,000 a month. While that amount might not be enough to fully retire, it certainly has the potential to free up some time and money in your working life.

But reaching the point of receiving $1,000 a month in secondary income from the share market is easier said than done.

Today, let's chart out this journey in five steps. Hopefully, this inspires readers to take the first step on their own journey to securing at least $1,000 in monthly passive income

Five steps to $1,000 a month in passive income

1. Get your financial house in order

If you're hoping to secure a stream of passive income from the share market, you will first need to ensure your own financial house is in order.

You'll have to start with any debts you might have. Owing money on your mortgage or your HECS account is one thing. But it's the 'bad debts' like credit cards, personal loans or car payments that you need to eliminate.

These loans for unproductive assets are a major drag on anyone's financials.

Once you've cleared any of these debts, you'll need to structure your personal budget to ensure that you always spend less than you earn. You can't build a stream of passive income without disposable income in the first place.

2. Build a rainy day fund

When you've got to the point when you're consistently spending less than you're bringing in, there's one more step to take before you start investing for passive income. That would be building a rainy day fund. Until you've secured a meaningful stream of secondary income, you're still at the mercy of life's ebbs and flows.

If you get sick, crash the car or have some other kind of unexpected emergency, it's vital to have a rainy day fund there to catch you.

The last thing you want to do is have to sell your shares at an inopportune moment, thanks to something out of your control. Having enough cash to cover three to six months' worth of living expenses is probably a good place to start.

3. Choose your passive income investments

Once your financial house is in order and you have amassed a healthy rainy-day emergency fund, it's finally time to start investing in the stock market. Passive income from stocks comes in the form of dividend payments. As such, you want to choose investments that pay a generous and rising stream of income, preferably fully franked too.

You can always start with popular dividend shares like Westpac Banking Corp (ASX: WBC), Telstra Group LTD (ASX: TLS) or Wesfarmers Ltd (ASX: WES).

Another solid choice is an income-focused exchange-traded fund (ETF). These investments bundle a wide range of dividend-paying stocks together in one easy investment. As we discussed earlier this week, two solid choices, in my view, are the Vanguard Australian Shares High Yield ETF (ASX: VHY) and the VanEck Morningstar Australian Moat Income ETF (ASX: DVDY).

4. Reinvest your dividends

Building a passive income stream worth $1,000 a month won't happen overnight, of course. Remember, buying $1,000 worth of shares that pay a dividend yield of 4% will only get you $3.33 in monthly dividend income to start with.

That's why you need to ensure that you are investing as much as you can, as soon as you can. However, you can turbocharge the process by reinvesting your dividends. This ensures that your capital is compounding as quickly as it can, as well as ensuring that you don't miss that money.

What you don't want to do is to take those dividends and spend them before you're enjoying that $1,000 a month in passive income.

5. Unleash the power of compounding

You're now well on your way to hitting that $1,000 in monthly dividend income. But, building on step four, our final step is to ensure that we are harnessing the power of compound interest as much as possible.

This will take time, probably many years. To achieve $1,000 a month ($12,000 annually) in passive income, you'll need to have, for example, a portfolio worth $300,000 that yields 4% income every year.

If one starts with $1,000 and invests $1,000 a month, it will take just over 13 years to hit $300,000. That's assuming an 8% rate of return and the reinvestment of all dividends. If you can somehow increase your monthly investment or achieve a higher average rate of return, this will cut down your timeframe dramatically.

Remember, compounding exponentially increases your returns the longer you hold the investment. Although it will take just over 13 years to hit $100,00 with the conditions stated above, if you wait for 20, you'll have close to $600,000.

Foolish takeaway

As you can see, building a stream of passive income using ASX shares is not easy. However, it is still one of the most straightforward paths to a secondary income stream most of us have access to.

The sooner you get started, the sooner you can start enjoying that $1,000 in effortless cash every month.

The post Here's my 5-step approach to earning passive income of $1,000 a month appeared first on The Motley Fool Australia.

Motley Fool contributor Sebastian Bowen has positions in Telstra Group and Wesfarmers. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Wesfarmers. The Motley Fool Australia has positions in and has recommended Telstra Group. The Motley Fool Australia has recommended Vanguard Australian Shares High Yield ETF and Wesfarmers. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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