A lot of people like the idea of passive income. Getting money without having to work for it sounds more attractive than the daily grind.
But in reality, a lot of people spend most of their waking hours working. Here’s how I’d earn a passive income even while working.
Working provides capital
While work may cost time, the good thing is it provides money. That makes it easier to build up capital which one can then invest with the aim of producing passive income.
Let’s say one puts away 10% of a monthly wage. Data from the Office for National Statistics and HMRC last October suggested the average monthly wage of full-time workers is around £1,919. 10% of that would be close to £200.
With £200 a month, after just a few months, I’d look to make my first passive income investment. Beginning with just one share, I’d want to limit my risk in the absence of diversification. So I’d go for a blue chip company whose prospects I found attractive, like Morrison’s. With its 4% yield, the supermarket chain should generate about £8 of passive income each year for each £200 I put in. So after a year, for example, my monthly contributions to date could already be making me about £96 of passive income for no work on my part.
But dividends aren’t guaranteed. For example, if Morrison’s suffers from increased competition due to discounters like B&M, its earnings could fall. So, once I had enough capital, I’d start to buy shares in more than one company.
Passive income ideas
That extra time would let me look around the market to see what sort of shares could meet my own passive income goals.
For example, some companies currently pay high dividends but their share price is low in anticipation of a cut. These are known as “yield traps” or “value traps”. That’s why I don’t just rely on historical dividend data. I also look at a company’s likely future earnings and free cash flows. To maintain and hopefully grow payouts, a company will need to grow its profits as these form the basis of dividends and thus passive income.
Looking at growth
I could look here for companies whose earnings I expect to grow because they are in improving markets. For example, consumer goods giant Unilever sells products in over 190 countries, at a variety of price points. As middle class populations grow in countries like China, India, and Ghana, I would expect demand for branded consumer goods to increase too. That could be good for Unilever, which already yields 3.7%.
Alternatively I could hunt for passive income ideas where I think a company might be able to grow income without necessarily growing sales. That sort of pricing power can be due to a unique product or strong brand loyalty.
While cigarette use overall may well decline in coming years, Imperial Brands believes that it can offset that by increasing prices. With a 9% yield, that could help them protect the dividend – and my passive income.
But what if pricing power isn’t as strong as Imperial hopes? What if competitors opt for a price war? In such a situation, sustaining earnings in a declining product category could prove difficult. That’s why Imperial Brands is only one of my diversified portfolio of passive income ideas – and I keep hunting for more.
