The appeal of unearned income is easy to see. But how easy is it to build passive income streams in practice? One of my favourite ways to try to do it is by building a portfolio of dividend-paying shares. I think I could get there by putting aside an affordable amount of money each week.
Here’s how I would aim to do it with £45 weekly.
Put money away regularly
While many people have plans about how to earn passive income, without putting them into action they will remain only as good intentions.
That is why I would get into the habit of saving a regular amount each week. The more disciplined I am about this, the more likely I will be to hit my goals over time. To save this money, I would set up some sort of share-dealing account. That way, as the money begins to pile up, I will be ready to start buying dividend shares when I feel the time is right.
If I could afford more than £45 a week I would invest extra. The more I invest, the greater my dividend income is likely to be.
Finding dividend shares
Next I would start to do some research and find dividend shares that could meet my personal investment objectives. I would start by focusing on large companies with long track records. That doesn’t mean they will necessarily be successful in future, but they could help me from falling into some common new investor mistakes of investing in high-yielding but short-lived companies.
To pay dividends, a company basically needs to generate free cash flow. So I would look for companies with highly cash generative business models that I felt could continue to do well in future. For example, utility National Grid and retailer Tesco would both be on my watchlist.
But no matter how attractive any one share may seem to me, unexpected events could hurt its dividend in future. For example, National Grid may need to invest heavily to reshape its electricity distribution network in line with changing user needs. Tesco’s growing footprint in the competitive online market could hurt its profitability. With smaller profits, a company has less scope to pay dividends.
That is why I would seek to diversify my portfolio across different dividend shares and industries. With £45 a week, I would have £2,340 a year. That’s comfortably enough for me to diversify across five to 10 shares.
Watch my passive income streams grow
If I can buy shares with an average dividend yield of 5%, I would hopefully be looking at an annual dividend yield of £117 from my first year of investing.
If I continue in the second year, I could buy new dividend shares but would hopefully still be earning dividends from shares I bought in my first year of investing. In this way, over time, £45 a week could lay the foundation for growing passive income streams. As the years went by, I might not miss my weekly £45 contribution as much as at the start — but I would hopefully notice my unearned income piling up!
