Passive income is money earned without working for it. One of my favourite passive income ideas is investing in shares that pay dividends. By doing that, I can benefit from the success of large companies such as Shell and Games Workshop.
Unlike some passive income ideas, I do not need to start with lots of money. In fact, it is possible for me to begin with nothing and put aside a few pounds a week to invest. Here is how.
Regular saving
At the heart of my plan is the idea of putting aside a small amount of money on a regular basis. Over time it can really add up. When I invest that, hopefully I will start earning dividends from it.
If I save £10 a week, it would add up to £520 a year. Imagine I target shares with dividends on average of 5% what I pay for them (this is known as the dividend yield). In that case, £520 would hopefully earn me £26 in dividends per year.
Once I own the shares, I should get any dividends paid for as long as I hold them. So in the second year, for example, I would hopefully get £26 from the shares I bought in the first year — but also dividends from shares I bought in the second year. Over time, even with a constant £10 a week, I would hope to see the dividends mount up. In fact, I could keep going for decades!
Choosing dividend shares for passive income
When it comes to choosing the shares to buy, I would follow a few principles.
First, I would diversify across different companies and industries. Dividends are never guaranteed, no matter how strong a company’s business is or its track record of paying out. Spreading my investments reduces my risk if one company I invest in stops its dividend.
Secondly, I would only buy shares in companies I personally understand. Maybe I read or hear about an exciting opportunity – I would likely want to learn more about it. But if I cannot personally understand a company’s business model and dividend potential then I will be unable to assess its suitability for my portfolio. I could do that by doing my own research, for example reading the company’s financial information and business results.
Thirdly, I would focus my efforts on finding great companies selling at an attractive price. I would manage my risk. For example, no matter how good a company’s dividend history, I would not invest in it if I did not think it could generate strong free cash flows in future to fund shareholder payouts.
Moving to action
This plan is not going to make me rich any time soon – or perhaps ever. But what I think it likely can do, for relatively little cash outlay each week, is build up long-term passive income streams. If they grow over time, they could end up becoming more substantial.
But a plan is only that. To start generating any passive income, I need to put it into action.
