How I’d set up passive income streams with £25 a month

By putting aside £25 each month to buy dividend shares, our writer hopes he can build his passive income streams. Here’s how.

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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.

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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.

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Christopher Ruane owns shares in British American Tobacco. The Motley Fool UK has recommended British American Tobacco. 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.

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