3 steps I’d take before buying UK shares for a passive income today

I’d use these three simple steps today in preparation for buying UK shares to make a passive income over the coming years.

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Buying UK shares to make a passive income can be a sound long-term move. After all, they’ve historically offered higher return potential than other income-producing assets. This point may be increasingly relevant in the current low interest rate environment.

However, there are risks involved in buying UK stocks for a passive income. As such, investors may wish to ensure they’ve sufficient cash on hand in case of emergency. It may also mean them having enough capital available to diversify, and check any potential holdings can afford their dividends due to the uncertain economic climate.

Holding cash as well as UK shares

Buying UK shares to make a passive income can be a wise move while interest rates are low. They offer significantly higher returns than savings accounts at the present time.

However, investing all of the capital available in shares and holding no cash may be a risky move. After all, the 2020 stock market crash showed that difficult periods for investors can happen at any time. Furthermore, personal financial challenges such as losing a job can happen to anyone at any time. Especially in the current economic climate.

Therefore, it may be prudent to always ensure there’s enough cash on hand to deal with possible financial ‘speed bumps’. Beyond this amount, UK shares can provide a worthwhile passive income over the long run.

Diversifying to make a worthwhile passive income

While it can be a good idea to focus on the most appealing UK shares when seeking to make a passive income, diversifying is likely to be a necessity for all investors. Otherwise, they may have a concentrated portfolio that carries too much company-specific risk. That is the potential for one or more companies’ poor performance to negatively impact on portfolio returns.

Clearly, a portfolio needs to be large enough to diversify. Therefore, before buying UK stocks for a passive income, it could be prudent to ensure an investor has sufficient capital to buy a wide range of shares. Otherwise, using tracker funds until that point is reached may be a sound move.

Ensuring dividends are affordable

Before buying UK shares to make a passive income, it could be a good idea to check they can afford their shareholder payouts. There’s little point in buying companies with high yields only for their financial performance to deteriorate so they have to cut, or even cancel, their dividends.

Clearly, dividend affordability is especially relevant at the present time due to the uncertain economic outlook. By taking simple steps such as comparing a company’s dividend payouts to its net profit and cash flow, it may be possible to buy the most resilient and robust dividend shares. Over time, they could offer a more dependable income stream that grows at a brisk pace to produce a worthwhile passive income.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

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