How I’d target £250 a month in dividend income

Christopher Ruane explains in detail how he would aim to earn £250 each month in dividend income by investing regularly in shares.

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Dividends can form a useful passive income stream. Over time, by putting more funds into shares, I hope to increase my monthly dividend income.

Here is how I would aim to get to £250 a month within five years, by investing £1,000 per month on average.

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Aiming for a certain dividend income

A couple of variables will determine how much dividend income I can start to generate over time. One is how much money I put in. The other is the dividend yield of the shares I buy.

I cannot control the second factor. But the first – how much I invest – is up to me. If I decided to invest around £1,000 each month, that would let me invest about £12,000 each year in dividend shares. I say “around” because in practice, the exact amount may vary. Realistically there may be some months where other spending needs take priority. Equally, in some months I may have a bit more than £1,000 to put into dividend shares.

But if I can manage £1,000 a month on average, that would give me a £60,000 investment pot at the end of five years. If I invested in shares with an average yield of 5%, that should generate £3,000 each year in dividend income — £250 a month.

If I only invest £1,000 each month, it would take me time to build up to my target. But while I saved and invested, I could still earn some dividends. So I might not hit my monthly £250 target for five years, but I could start earning at least some dividend income within just a few months.

Choosing the shares

I would diversify across different shares and business sectors. That would help to reduce my risk in case things turned out worse than I expected for a share I bought.

Although it can be tempting to focus heavily on dividend yield, I would consider some other points when choosing shares for my portfolio. I would want to see how well dividends were covered by a company’s free cash flow, for example. Ultimately a company needs sufficient cash to pay dividends each year. Free cash flow figures could help me see whether a company has enough money to do that.

Additionally I would think about how a business may do in future. To set up dividend income streams for the long term, I would want to invest in businesses that seem to have the ability to grow their earnings as the years go by.

Two dividend income ideas I would use

An example of a company I would consider is consumer goods maker Unilever. Its portfolio of premium brands gives it pricing power. So although there is a risk that inflation could hurt profit margins, hopefully the company could increase prices to maintain its profitability.

Unilever yields 3.7%, below my target average of 5%. But I could compensate by buying some shares with a yield above 5%. For example, Legal and General yields 6.3%. So the average of this financial services company and Unilever should yield me 5%. I like Legal & General’s proven ability to generate sizeable profits: last year’s post-tax profit from continuing businesses was £1.3bn. One risk to profit margins is the impact of new UK rules on renewal pricing for insurance policies. But I think a strong brand and resilient demand for products such as insurance should help the company keep producing profits. 

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Christopher Ruane owns shares in Unilever. The Motley Fool UK has recommended Unilever. 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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