Work, work, work. Whether you enjoy working or not, the idea of spending loads more hours each week doing it often has limited appeal. But what does have appeal for many people including myself is the idea of earning a bit of extra money each month. That is why one of the passive income ideas I use is investing in dividend shares.
Imagine I had a certain target in mind for the passive income I wanted to try and earn each month doing that, for example, £100. Here are the steps I would take to aim for that by buying dividend shares, even if I had never invested in the stock market previously.
Step one: getting ready to buy shares
To earn dividends I would need to buy shares. But before I can do that, I need to do the housekeeping to be ready to trade.
So, for example, I would set up a share-dealing account or Stocks and Shares ISA. That way, once I have money and know what dividend shares I am looking to buy, I will be ready to act.
Step two: setting a monthly passive income target
Different companies pay out dividends on their own schedule. Some pay only irregularly or not at all. Dividends are never guaranteed, after all.
So although I could target shares that typically paid out in specific months, I would find it easier to target an average of £100 per month across the year rather than the same amount each month. That would add up to £1,200 in the course of a year.
My prospective earnings from the shares depend on what is known as their dividend yield. That is basically the annual dividends I should receive as a percentage of the price I pay for the shares. If I invest in shares with an average yield of 5%, I will need to invest £24,000 to hit my target. If the average yield is twice that level at 10%, I will only need to invest half as much – £12,000.
Step three: choosing the right dividend shares for me
So does that mean I should just go for the highest yielding shares?
Absolutely not, without more information! Purchasing a share is like buying a tiny sliver of a big company such as BP or Apple. The dividend yield in itself, which for those two companies is 3.9% and 0.6% respectively, tells me nothing about the business.
Following the thinking of billionaire investor Warren Buffett, I would adopt the mindset of an investor buying a little piece of a business. So I would look for a business area I felt I understood and where I expected to see strong customer demand in future. I would then try to find companies that had a competitive edge in that industry. I would also check whether they had high debt or other spending obligations that might deter them from using profits to pay dividends.
Step four: start buying and earning
If such dividend shares were available to me at an attractive price, I could start building my income-generating portfolio.
Like dividends, though, company prospects are never guaranteed. So I would try to reduce my risk by diversifying across a range of dividend shares.
