How I would target a £3,000 annual passive income from dividend shares

With a passive income target of £3,000 each year, our writer explains how he’d try to hit it by investing in dividend shares.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I want to boost my income and investing in dividend shares is one option I would consider. By owning shares that pay out dividends, hopefully I could start generating what are known as passive income streams – in other words, earnings for which I do not need to work.

How would I do this if I had no previous experience buying shares? Here is is one way I would go about it as I aim for passive income streams of £3,000 per year.

The link between income and yield

If starting with a target income in mind, it is important to understand the concept of yield. Just as an interest rate indicates how much income I would expect to receive on £100 of savings, yield shows the same for dividends. So a dividend yield of 5% means that if I owned £100 of shares in a company, I would expect £5 of dividend income per year from it.

Dividends are never guaranteed though, and a company can stop them at any time. So I do not see a company’s prospective dividend yield as offering me the certainty of return I would typically get from the interest rate on a savings account.

If I did invest in shares with an average yield of 5%, to target £3,000 of annual income I would need to invest £60,000. For a higher yield I would need less – if I invested £30,000 at an average 10% yield, I could hopefully target £3,000 of annual passive income. But higher yields can often indicate a higher risk.

Focus on quality

That is why I would not just look at a list of dividend shares and focus on those with the highest yields. Instead, I would try to find shares that I felt could sustain — and hopefully increase — their dividends over time.

So, for example, Guinness owner Diageo has a portfolio of premium drinks brands that give it pricing power. That can help it offset the potential profit impact of rising production costs as inflation hits. The company is highly cash generative, something that can help it pay consistent dividends. Indeed, it is one of a small number of UK shares that have seen their dividends increase annually for more than a quarter of a century. At the moment though, Diageo’s dividend yield is a modest 2%. So, while I could earn passive income from it, to aim for earnings of £3,000 a year just from Diageo shares would require me to invest £150,000.

Passive income from a diversified portfolio

But in reality, I would not invest my whole portfolio in one company. No matter how good it is, some unforeseen problem in its business could hurt its future ability to pay a dividend. Instead, I would spread my funds over a diversified group of shares and companies.

Some may have lower yields and some higher ones, but the average yield is what determines how much I need to invest to target £3,000 each year in passive income. However much I would need, if I do not have it today I could still start drip-feeding in a smaller amount. Even if I do not hit my £3,000 target straight away, I could hopefully build up to it over time as my funds allow.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. 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.

More on Investing Articles

Investing Articles

Can the filthy cheap BP share price rocket in 2025? Here’s what the experts say

Harvey Jones took advantage of a tough year for the BP share price to add the stock to his portfolio…

Read more »

Investing Articles

I aim for a million buying just 10 or so shares!

Rather than investing in dozens of different companies, our writer is focussing on finding a few great ones to help…

Read more »

British Pennies on a Pound Note
Investing Articles

Has this 6% yielding penny share fallen too far?

After a testy few days for a penny share our writer holds, he revisits the investment case and weighs management…

Read more »

Investing Articles

These are the 3 top-yielding FTSE 250 stocks in my passive income portfolio

Mark Hartley explains why these three mid-cap stocks make good additions to his passive income portfolio, despite lacking the stability…

Read more »

Investing Articles

3 stock market pitfalls for beginners to look out for

When investing in the stock market it's easy to fall foul of these three big mistakes. Our writer considers some…

Read more »

Growth Shares

The second phase of AI’s started. I expect these UK shares to benefit

Edward Sheldon believes these UK shares could do well as artificial intelligence solutions are introduced within the corporate world.

Read more »

Investing Articles

How much will be needed to start buying shares in 2025?

Christopher Ruane explains why he thinks it need not cost the earth to start buying shares and details some considerations…

Read more »

Investing Articles

Can the Next share price defy the odds and grow another 25% next year?

Harvey Jones is in awe of the Next share price, which has shrugged off the troubles hitting retail for another…

Read more »