Seven steps to creating passive income from the stock market.

I have made it known to my family and many friends that I aim to create a minimum of $50k in annual passive income from investments in the stock market alone.  Recently, while chatting in the cbox at Bully the Bear, I mentioned this and at least one person was incredulous.  How to achieve this?

Well, to me, it's quite simple, if I invest $500k in a basket of stocks that yields 10% per annum, I would have that $50k passive income.  Then, I gave it some thought later  on and decided that perhaps I should share more in detail how this could be achieved.

Taking a leaf from successful authors using the number "seven", this is AK71's "Seven steps to creating passive income from the stock market":

1.  Get full time employment - Sounds dreadfully straightforward, doesn't it?  Well, sometimes we need to point out the obvious.  We cannot grow money in pots of soil or fabricate it at home; well, not legally anyway.  Get a well paying job that pays you as much as you are worth (or more than you are worth if you are lucky enough).  Don't shortchange yourself.

2.  Be frugal - Again, this sounds straightforward enough but it is something that many people find hard to do.  Instant gratification is so common in our modern world, isn't it?  I want something and I want it NOW!  It is quite well known that George Soros takes the subway to work and that the founder of IKEA is still driving the same Volvo he bought more than 20 years ago!  I blogged about this recently.
Money management: Needs and wants.

3.  Save as much as you can.  OK, I'm cheating here.  This is really a combination of points 1 and 2.  Make as much as you can in your full time job and spend as little as you can.  The difference: savings.  This is your initial capital to realise your dream of passive income from the stock market.  Also, remember, money in your CPF-OA is savings and a percentage could be used to invest in the stock market too.  Start a SRS account and use the money to invest in the stock market at the right time.
Things Singaporean: SRS, CPF-OA and CPF-SA.

4.  Fundamental Analysis (FA): go learn FA if you have not done so already.  This is very important in the identification of good companies in your quest to build a passive income stream from the stock market.  This cannot be emphasised enough.  Look for companies with high yields but ensure that they have a strong balance sheet and good cash flow.  Do not look at the income statement only.  Otherwise, it might come back to haunt you.
Fundamental analysis: The income statement.
Fundamental analysis: Balance sheet.
Fundamental analysis: The cash flow statement.

5.  Technical Analysis (TA): go learn TA if you have not done so already.  If FA tells you a company has a fair value of $1 and the price is now 80c, is this good enough to buy?  Well, if the company's share price is going through a downtrend, no.  Cheap might get cheaper.  That's what TA can do for you: it shows you the trend, resistance and support levels.  FA cannot do that.  Market sentiments do not care two hoots what is the fundamental value of a company and you will do well to remember this.
Thoughts on methodology.

6.  Invest in the good companies you have identified and monitor them constantly.  There are quarterly and annual reports to analyse.  Use FA to ensure that they are still doing well and likely to continue doing well in future.  Use TA to check on the longer term trends. 
Identifying trends and value: FA and TA.
Risks and rewards: TA and FA.
Monitoring our stocks.

7.  Reap the rewards of your investments and collect the dividends.  Yes, finally, we get to the fun part!  You can decide if you want to use the dividends to reward yourself or if you want to add to your pool of savings to be re-invested.  Of course, if you want to achieve a higher passive income within a shorter period of time, re-investing is the answer.  Just employ FA and TA again to do this.

In the meantime, if you did not get retrenched (knock on wood), ensuring that you continue to save as much of your earnings as you can from your full time job will continue to grow your pool of savings even as dividends received from your investments pour in.  Year after year, your annual income increases through greater contributions from the passive income received through your well thought out investments (everything else being equal).  Sounds really good, doesn't it?

Before long, you would have a significant stream of passive income supplementing your earned income from employment.  After some time, your passive income might equal your earned income and that's when you work because you want to and not because you have to.  Now, if this does not convince you, I don't know what will.

It is definitely possible to create a significant passive income stream from investing in the stock market.  Like so many things in life, there is just no short cut though.  So, if this is your dream just like it is mine, get cracking.  Good luck.  Yes, you will need some of this too.

Finally, remember, if you find some good companies out there which the analysts haven't discovered yet, come back here and share with us.  This is most important.
Stock market analysts.

P.S. For the sake of brevity, "companies" in this post refer to REITs and business trusts as well since these are primarily dividend instruments and must be considered in our quest for passive income from the stock market.

Related post:
Recommended books for FA and TA.