Setting up passive income streams could help me supplement my income without adding to the daily grind. One of my favourite ideas is buying dividend shares in successful, well-established and profitable companies. I think I can do that even starting with a small amount of money.
Here is an example of the approach I would take if I wanted to put aside £25 a month.
Save a realistic amount regularly
I could choose £50 a month or even £500 a month. But one of the benefits I see in aiming for £25 is that it as a realistic amount to set aside each month, even if other unexpected expenses pop up. To have its desired effect, I think a passive income plan ought to be predictable.
This monthly contribution would form the core of my savings, which I would then invest in dividend shares. It would take me a few months before I had saved enough to start investing, but during that time I would set up some way to buy shares. For example, if I did not have one I would open a share-dealing account, or Stocks and Shares ISA.
Hunting for dividend shares to buy
Next I would start to learn more about the stock market. Dividends are basically a tiny sliver of a company’s profits. If a company makes a loss one year, it may still pay a dividend. But if it loses money year after year, it is unlikely to pay a dividend, even if it has done so in the past.
So I would focus on understanding what sorts of companies typically pay dividends. For example, although earnings are an accounting term, free cash flow is what a company actually pays dividends from. That is why I would read up on the basics of how to tell what a company’s free cash flow is – and what it is likely to be in future.
£25 a month adds up to only £300 a year. That is enough to invest, but I would also try to manage my risks. One way I would do that is by diversifying across different shares and industries. For example, if I buy both BP and Shell but no other shares, a slide in the oil price could hurt all my dividends. But if I put the same money into BP and Next, a reduced oil price could hurt the BP dividend but is less likely to affect the payout at Next.
Setting up passive income streams
I would only invest in large companies with proven business models. I would look for evidence of consistent historic profitability, which a lot of dividend payers like National Grid and British American Tobacco offer.
But my investment is forward looking. So I also need to find companies I think should be able to continue making profits and paying dividends in years to come. Companies with some competitive advantage in a resilient industry would be high on my list.
If I own shares with a dividend yield of around 5%, £300 would earn me only £15 a year in passive income streams. That is not much — but it is a start. Over time, as I put more money aside and find promising shares to buy, hopefully my passive income streams will keep growing.
