Of all possible passive income ideas, one of my favourites is buying dividend shares. That is because I can start with hardly any money, and gradually build up stakes in successful, profitable companies. Over time, if they pay dividends, I will hopefully see my passive income streams build up.
One way to do this would be to start saving a small amount regularly, such as £5 a day, in a Stocks and Shares ISA. Here is how I would do it.
Saving a little, often
£5 a day might sound too little an amount to be worth investing. But in fact it soon adds up. If I started today then by the end of 2022 I would already have almost £1,500 to invest. That is a significant amount, in my view. If I invested it in dividend shares with an average yield of 5%, I could hopefully expect around £75 in passive income from dividends next year.
But things get better than that. Once I own shares, if they pay dividends I get them until I sell the shares. So, imagine I keep putting aside £5 a day next year. If I buy more shares with the same average yield of 5%, that will hopefully generate around £91 of dividends annually. But I would also hopefully receive another £75 of dividends from the shares I buy this year. Over time, drip-feeding £5 a day into my Stocks and Shares ISA could help me generate growing passive income streams.
Reward and risk
One temptation some investors face when investing is trying to boost their dividend income by choosing high-yielding shares.
In itself, that can make sense – I own M&G with an 8% yield and 9% yielder Imperial Brands, for example. But it is important not to chase dividend yield and ignore risk. All shares carry risks, but high yields often indicate City scepticism that a company can keep paying out its dividends at the current level. Sometimes, such doubt is misplaced. But on other occasions, a high-yielding share could turn out to be a yield trap, where a high dividend ends up disappearing.
Every investor needs to decide what their own risk tolerance is. But if I was investing for the first time, I would err on the same of being overly cautious when it came to risks. I would also buy a variety of shares across different industries in my Stocks and Shares ISA. That diversification could help lower my risk if a share I bought ended up cutting its dividend.
Keeping or reinvesting passive income
Different Stocks and Shares ISAs have a variety of rules and fees. But typically I could have the choice either to withdraw my passive income as cash, to reinvest it in the shares that gave me dividends, or use it along with my ongoing £5 a day to buy new dividend shares.
Over time, I think I could increase my passive income streams, using just £5 a day. With this year’s Stocks and Shares ISA deadline less than a month away, I would start putting my passive income plan into action today.