Passive income is money that comes in without having to work for it. Bank interest and share dividends are classic examples. In fact, share dividends are among my favourite passive income ideas. Here is how I would consider aiming to set up weekly passive income streams of £100 by investing in UK dividend shares.
Dividend shares and passive incomes
Dividend shares are ones which pay out money to shareholders. Not all shares pay dividends. Some may pay dividends when the business is performing well, but not when it does less well. In fact, no dividends are ever guaranteed.
However, at any time in the stock market there are typically dozens of companies who pay dividends. If I buy these shares, I can sit back and simply wait for any future dividends. They would provide passive income for me.
Setting my passive income target
Let’s say that I want £100 a week of passive income. That’s £5,200 a year. A dividend’s ‘yield’ is the percentage of its share price it pays out as dividends. So, if I can find shares yielding 10%, I could invest £52,000 and hope to meet my annual dividend target. Whereas if I invest in shares yielding 1%, I would need to invest over half a million pounds to hit my passive income target.
The challenge is that most shares pay closer to a 1% yield than a 10% yield. Sometimes shares which do have a high yield are priced to reflect a perceived risk of a dividend cut. They can be what is known as a ‘value trap’, a share that seems cheap but in fact might not turn out to be a bargain at all.
But if I look hard, I reckon I could find some high yielding shares I would happily add to my portfolio. I would focus on a company’s likely future performance rather than its historical dividends. Then I would look for companies with a high yield I thought might not be value traps.
For example, British American Tobacco yields 7.8%. That could be because declining smoking rates hurt future profits. But if that risk doesn’t materialise, the prospective yield looks attractive. The financial services provider M&G yields 8.8%. Like BAT, that high yield could signal a value trap. One risk is declining demand for M&G’s services leading to falling profits. But it could turn out that M&G has bright prospects. I would consider adding it to my passive income list.
Crucially, I’d split my money between a variety of companies and industries. That helps diversify my holdings, and reduces my risk.
Putting the plan into action
I’d start hunting for a range of dividend shares I find attractive, and then put my money in. But what if I didn’t have enough to invest right now to meet my weekly passive income target? If I target an average 5% yield I would need to invest £104,000, after all. That’s a lot of money.
In that case, I’d start with what I could afford, applying the same principles. Over time as my portfolio gets bigger, my passive income streams would hopefully follow. Even if I didn’t hit £100 in weekly passive income just yet, I’d have made the move to get started.
