A little bit of passive income can be useful for the occasional splurge. I think putting aside a fairly modest sum each month could be enough for me to set up some passive income streams. The returns would likely be low at first, but over the years I would hopefully see them grow.
Dividend shares as passive income
One of my favourite ideas for effortless earning is investing in dividend shares. The process is pretty simple. First, I would set up a share-dealing account or Stocks and Shares ISA. Secondly, I would start contributing money to it regularly. Thirdly, once I had saved enough funds in it, I would start buying dividend shares.
I like dividend shares as an option because of their simplicity. I can get any money they pay out as dividends, without needing to do anything myself to earn it. Such shares offer me exposure to some of the leading companies in the UK and indeed the world. In future, if I change my mind about a company, I can sell the shares.
Dividends are never guaranteed though. For example, a company may see a decline in profits because of increased competition. That could lead it to cut its dividend. That is why I would invest in more than one company’s shares. Diversifying across companies and business sectors would reduce my risk if one of my choices turned out badly.
What could £30 a month earn?
£30 a month is around £1 a day. I think it is a very manageable amount for me to save. That would add up to £360 in a year.
The average dividend payout on shares in the FTSE 100 index of leading companies tends to be between 3% and 4%. That would suggest I could earn roughly £11 to £14 a year in passive income each year. That doesn’t sound much. But once I own shares, I get any dividends a company pays until I sell them. The £30 a month would start adding up. So, in the second year I would get dividends from £720 worth of shares, in the third year £1,080 and so on. All of that would be from putting in a steady £30 a month. And if I reinvest my dividends, the amounts can add up even faster.
It is also possible to target companies with dividends above the average. Some companies are out of fashion or risk declining customer demand leading to smaller revenues and profits, for example. So their dividends may be higher as a percentage of their share price (what is known as ‘yield’) than the average. Tobacco company Imperial Brands is an example. It yields 8.4%. But I need to be careful here not to choose shares whose prices continue to decline.
Choosing the right shares for me
Whichever shares I chose, I would make sure to diversify. I would also focus on a company’s future prospects, not just its current yield. A juicy yield today is less attractive to me if the company’s future profits will not be able to support the same level of payouts.
Saving £30 a month would mean it took a few months before I had saved a big enough sum with which to start buying dividend shares. I could use that time to do some research. I would seek to identify shares that matched my risk tolerance and passive income objectives.
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Christopher Ruane owns shares in Imperial Brands. The Motley Fool UK has recommended 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.