Is it really possible to target almost £1,000 of passive income a month when starting with £20,000? That may seem too good to be true, as it seems to imply a 60% annual rate of return.

The answer is that it is possible, but in the example I am going to share, this is not a short-term financial fix. Taking the long-term approach is necessary – but it could pay off handsomely in the end.

Using the stock market to your advantage

This is not some wacky passive income plan about setting up an online business. Rather, it involves investing the £20k in businesses that are long-established and already proven, spreading it across a diversified range of blue-chip shares, and scooping up dividends that they pay.

Dividends are payments a company makes to its shareholders. Not all businesses pay them and even those that do can stop at any time. Still, dividends can be very lucrative.

FTSE 100 companies alone pay out more than £1bn a week on average in dividends. That is a lot of passive income for investors!

Here’s how £20k could generate £982 a month

Say the £20k is invested at an average yield of 6.5%. That would mean it earns 6.5% in dividends annually, so on a £20k investment we are talking about £1,300 a year. That is around £108 a month.

Instead of taking those dividends in cash though, the investor could choose to reinvest them – something known as compounding. They could stop at any time and start taking the dividends in cash. But the longer they compound, the more powerful the impact on their portfolio.

For example, compounding £20k at 6.5% annually for 35 years, it would grow to over £181k. At a 6.5% yield, that would generate some £11,780 of dividends annually. That equates to £982 a month of passive income.

Getting ready to invest

That 6.5% is over double the current FTSE 100 yield of 3%. But with careful selection of shares, I think it is achievable in today’s market

Of course, the investor also needs a practical way to invest. Fees can cut into returns – and ultimately therefore passive income too – so it pays to shop around when looking for a share-dealing account, Stocks and Shares ISA or trading app.

One income share I’ve been buying

I can illustrate this passive income-earning approach with a share in my own portfolio: homewares retailer Dunelm (LSE: DNLM). Currently, the FTSE 250 share yields 6% and has been growing its ordinary dividend in recent years.

The total yield is higher though, because Dunelm also pays a special dividend with excess cash.

When looking at a share, the current yield may grab attention — but the key question from a passive income perspective is what future dividends may look like. Dunelm has had a rocky start to its current financial year, with warm weather dampening shoppers’ enthusiasm for buying its goods. If that trend continues, it is a risk both to sales and profits.

Still, that helps explain why the share price has taken a tumble. So I have taken advantage of that to buy the share, as I like Dunelm’s profitable, proven business model, shop opening plans and strategic shift to selling fewer items, something I think could boost profitability.

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Christopher Ruane owns shares in Dunelm.