Passive income is money someone earns without having to work at it. That could be anything from rental income to dividends. The attraction is obvious: money comes in without having to lift a finger. That makes life less difficult and more affordable.
One myth is that one can’t earn such income it unless one has a lot of capital. In fact, it is possible to start earning with even small savings. Below, I explain how I would start earning passive income by putting aside just £100 a month.
I’d make a habit of regular saving
One thing a lot of investment veterans agree on is the power of habit. Some people spend their lives waiting for some future moment when they have spare money in the bank. Instead, I would make a start now with a regular habit of saving money. I’d make a habit of saving a minimum set amount each month, starting now. No matter what other expenses come up, if I could stick to that target I would be less likely to miss that money from my wallet each month.
To put the money to work as fast as possible earning passive income, I’d regularly invest it into a Stocks and Shares ISA. Then as the funds grow, I’d start to buy shares in a range of companies.
I’d buy shares that meet certain criteria
Not all shares are attractive if one’s objective is income. Many companies do not pay out dividends, as they prefer to retain the money inside the company to fund growth. Instead of those growth names, I’d go for income shares. Those pay out dividends.
For me there are three key criteria to consider when investing for passive income. First I’d look to see how often a share pays out. Some shares only send a dividend cheque once a year. I’d rather have a frequent payer like British American Tobacco, which makes quarterly payouts.
Secondly, I would look to see how sustainable a company’s dividend is. Some companies offer high dividend yields by paying out more than they earn. I don’t see that as sustainable long term. Instead, I’d want a company that has stable or growing earnings and rarely if ever pays out more than it earns. For example, Morrison’s yields over 3% yet earnings still covered its dividend almost two and a half times last year.
Finally, I would look for a company which tends to pay dividends through thick and thin. During economic downturns, a lot of companies reduce or suspend their dividend payments. I’d prefer to choose a stock that keeps on paying, such as Spirax-Sarco Engineering. It has increased dividends each year for five decades.
I’d reinvest my dividends to increase my passive income
In the beginning, the dividends might look small. But as the monthly contributions pile up and the dividends roll in, I would expect my earnings from this approach to become more substantial.
Instead of withdrawing the dividend income on a regular basis, I would prefer to take the next step and reinvest the dividends into more shares. That way, the value would compound.
