My £3 per day passive income plan

Our writer thinks this passive income plan could help him earn extra cash by investing regularly.

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Setting up passive income streams does not have to cost the earth. By investing in dividend shares, I think I can start to generate some extra cash without needing a lot of money upfront. Putting aside £3 per day, here is the passive income plan I would use.

Regular saving

At the heart of this approach lies regular saving. £3 a day may not sound like a lot, but it adds up over time. In one year, putting aside that much daily would give me over £1,000 to invest.

I think it is important that I focus on sticking to the saving plan with regularity. There are often unexpected spending needs that pop up in life. If I keep skipping planned savings, my investment pot will grow more slowly — and I may lose the momentum altogether.

Get ready to invest

In the early days, I would open a share-dealing account or Stocks and Shares ISA. That way, once I have saved enough money and am ready to start buying shares, I could do so immediately.

Find shares to buy

As the money started to add up, I would have time to learn about the stock market and choose shares to buy. Different people have a variety of investment objectives and risk profiles. So I would want to develop my own understanding of shares and what ones might help me hit my passive income goals.

Dividends are basically a slice of a company’s profits paid out to shareholders. So I would focus on businesses I reckoned had the opportunity to make substantial profits in future. To do this, I would learn not just about their earnings but also cash flows. Earnings are an accounting measure, but cash flow is the money coming in (or going out) of the door each year. That is critical to pay dividends in the long term. A company’s cash flow statement could therefore help me understand its dividend potential.

Some investors just choose shares with the highest dividend yield. For example, Rio Tinto yields 10.3%. That means that if I invested £100 in it, I would hope to receive £10.30 in dividends next year. The problem I see with only concentrating on dividend yield is that it just tells me what a company currently pays outs as dividends. That does not help me understand its possible future profits and cash flows.

So first I would try to find companies that match my investment strategy. Only once I had found businesses I felt had long-term profit potential would I start to consider their dividend yields.

Sticking with my passive income plan

No matter how well I do my research, some income shares may turn out to be less lucrative than I hoped. That is why I would diversify my portfolio by investing in a range of companies.

My passive income streams would be modest in the beginning. Investing the first year’s savings in shares yielding an average of 5%, for example, I would expect annual dividends of around £55. But if I kept contributing daily, over time my passive income plan would hopefully deliver me growing sums.

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 no position in any of the shares mentioned. 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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