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Should I use a spare £300 to generate passive income?

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A bit of passive income could come in handy from time to time. But it isn’t always necessary to have a very large sum to invest to start generating passive income. Let’s say I had a spare £300 at the end of the month. I reckon that would be sufficient for me to generate a modest passive income. Here’s what I would do.

Dividend shares as passive income ideas

My plan to use the £300 to generate passive income would be to invest it in dividend shares. If they paid dividends in future – which is never guaranteed – I would have a passive income source. Admittedly I wouldn’t expect that much passive income. Even shares yielding 7% or 8%, among the highest yields of FTSE 100 shares, would only be generating around £21-£24 in passive income a year. Still, that’s something. If I had a spare £300 now, I could tuck it away. Each year from now on, hopefully it would give me enough income for a decent lunch or theatre ticket.

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Additionally, if the shares increase in value over the time I hold them, I might see my stake of £300 grow in value too. But the reverse could also happen.

The challenge of diversification

Typically, in order to reduce my risk, I diversify my investments between different companies and industries. If the £300 was on top of my existing portfolio, that would already give me some diversification. But what if the £300 was the only money I had to invest in the stock market?

Diversifying adequately with that amount could be a challenge. That is because many share-dealing accounts charge a minimum transaction fee. Let’s say that’s £10, as an example. If I bought shares in one company, I’d get £290 worth after fees. But if I wanted to diversify across three shares I’d only get £270 worth after fees. In other words, I’d have lost 10% of my £300 in this example on fees before I even earned a penny of passive income.

One solution could be for me to seek diversification by investing in a share which itself holds a wider basket of investments. One I would consider is the Income & Growth trust. Not only could this give me some diversification, it also has attractive dividend prospects.

Alternatively, I might buy shares in two different companies and just accept that the fees were a price worth paying for the benefit of diversification.

Choosing individual dividend shares for passive income

If I did decide to buy shares in a couple of different companies, I would split the money across different industries. I like the yields offered by tobacco companies such as British American Tobacco and Imperial Brands. Both currently yield over 8%, though there is a risk that falling cigarette demand could hurt revenues and profits.

I would also consider financial services, a sector which currently offers some attractive yields. For example, Legal & General (yielding 6.0%), Direct Line (8.4%), and M&G (9.3%) would all make my list of dividend shares to buy now for my portfolio. But again, I’d keep a keen eye on risks, such as the impact of any economic downturn on customer demand.

£300 isn’t a huge amount. But I reckon it’s enough to allow me to set up passive income streams which, with no further work from me, could hopefully generate money for me for years or even decades to come.

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Christopher Ruane owns shares in British American Tobacco and Imperial Brands. The Motley Fool UK has recommended British American Tobacco and Imperial Brands. 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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